The latest Australian dollar sell-off is a red flag for the economy

There’s a lot going on in the world, and the story is encrypted in the Australian dollar.

So, let’s decode it.

The first thing to note is that the Aussie dollar has been weaker against the greenback over the past week, after a strong rise in the weeks prior.

Key to the weakness this week was the release of inflation data showing price pressures in the economy seem to be contained.

Then, on Friday, US President Donald Trump announced dates for the implementation of tariffs on Canada and Mexico and said the US would impose a further 10 per cent tariff on Chinese goods.

That’s put the global economy on edge, which encourages further selling of the Aussie.

The Australian dollar sell-off suggests that while we may be slowly digging our way out of the cost-of-living crisis, global economic storm clouds are gathering.

Those clouds threaten to derail the RBA’s impressive achievement of sustaining tighter monetary policy and a strong jobs market.

Trump in, dollar down

The fall in the Australian dollar marks a significant shift in the economic environment that affects all Australian households.

In September of last year, the Australian dollar was trading at near 70 US cents.

Then, over the space of a few months, it tumbled.

Why? Donald Trump was elected president of the United States. He threatened to put tariffs on Canadian, Mexican and Chinese goods entering the US.

It led to a surge in demand for the US dollar and, together with evidence of weaker Australian inflation, led to the local currency sliding to a five-year low of just under 61 US cents.

In recent weeks, the Australian dollar rose — largely related to US dollar weakness and evidence the American economy may be weakening.

But now it’s sliding again, down to 62 US cents. So, what’s changed?

Local economic data this week was telling

The Bureau of Statistics Monthly Consumer Price Index Indicator showed headline inflation steady at 2.5 per cent.

Core inflation rose from 2.7 per cent to 2.8 per cent but it remains within the RBA’s target band of between 2 and 3 per cent.

Crucially, though, the key services elements of the inflation data are looking less sticky.

Rent inflation fell from 6.2 per cent in the 12 months to December to 5.8 per cent in the 12 months to January.

The increase in out-of-pocket healthcare costs was steady at 4 per cent.

And insurance and financial services costs growth rose only fractionally from 5.2 per cent to 5.3 per cent.

The local financial markets reaction was tame — the Aussie dollar didn’t budge too much.

But once offshore traders took a look at the dollar there was an orderly but continuous move out of the local currency.

Then RBA Deputy Governor Andrew Hauser did all but confirm to a parliamentary committee that there were more interest rate cuts on the horizon.

He did this by indicating that, according to the RBA’s forecasts, inflation would likely overshoot the target of 2.5 per cent if interest rates were not lowered this month.

Indeed, the bank’s 2027 inflation forecast of 2.7 per cent is based on the assumption of several more interest rate cuts.

It should be noted, though, that the RBA has not provided any forward guidance on interest rates.

Still, the cost-of-living crisis seems to be abating, and it’s being reflected in the recent slide in the Australian dollar.

What about China?

Trump’s latest tariff announcement saw the Australian dollar take another leg down, as valued against the greenback.

“The Aussie’s hopes for a quiet glide into the weekend were punctured by President Trump’s unscheduled announcement that heavy tariffs on Canada and Mexico would proceed as scheduled on Tuesday, along with another (unscheduled) 10 per cent extra tariff on Chinese goods,” InTouch Capital Market Senior FX Analyst Sean Callow said.

“The Aussie is now back to lows since February 4 and seems likely to remain under pressure unless furious lobbying by Canadian and Mexican diplomats wins another reprieve.”

The tariff threat against China is particularly problematic for Australia.

China is Australia’s largest trading partner, and the world’s second largest economy is already under significant economic and financial pressure.

A recent note from the National Australia Bank suggested there were emerging risks of a regional bank run as lenders’ positions in the bond market turned against them.

The NAB made comparisons to the Silicon Valley Bank run of March 2023.

China has also been throwing hundreds of billions of dollars at its economy to prime it, but it’s had little impact so far.

The added impost of further tariffs threatens to slow China’s economic growth, and therefore significantly dent Australia’s economic fortunes.

These threats and fears are being priced into the Australian dollar as we speak.

“[Recent] developments have caught the broader FX market at a time when there seemed to be little priced in in the way of tariffs,” Deutsche Bank currency analyst Lachlan Dynan said.

“A larger tariff premium seemed deserved for the US dollar as a whole, and markets are having to wake up to that.

“As well as a broader rise in the US dollar, the market looks to be placing additional pressure on the Australian dollar given further US tariffs on China, Australia’s largest trading partner.”

Markets might see these as more likely to stick, Dynan said, whereas Canada and Mexico managed to negotiate delays weeks ago.

“The Aussie is also sensitive to broader global risk sentiment and moves in US equities, and these [have been weaker].”

He added: “US equities had been resilient to tariff threats in the past, but amid market concerns about US growth and inflation expectations, US equities are struggling to shrug off further bad news in the way of tariffs.”

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But here’s the bigger problem…

Wall Street sees billions of dollars in securities change hands every day.

And what happens on Wall Street has implications — valued in the trillions of dollars — across the globe.

AI chips designer Nvidia fell 8 per cent on Thursday because, despite very impressive earnings results, it wasn’t quite as solid as the market was expecting.

Make no mistake though, global investors are pricing in an AI revolution and a positively wonderful economic environment of low inflation and strong jobs growth.

There is, of course, the possibility AI won’t meet expectations of how it can revolutionise global business productivity and Trump’s tariffs threat to create an environment of higher inflation and lower economic growth.

All Asian share markets were down sharply on Friday.

The problem with this phase in the share market cycle — “greed’, when investors look for reasons to push stock prices beyond record highs — is that they tend to ignore reality.

The reality is that the US budget position is unsustainable and tariffs seem to be Trump’s policy of choice to rectify the nation’s finances.

The implementation of tariffs threatens to up-end the progress made on reducing global inflation.

That includes Australia.

An additional problem for Australia is that slower global growth could also put jobs at risk.

The result would jeopardise the Reserve Bank’s hard work reducing inflation without hurting the jobs market.

Trade in the Australian dollar is reflecting all of this.

“The Australian dollar looks like it’s on its way to a re-test of the February lows around $US0.61 as Trump continues to ramp up the tariffs,” AMP’s chief economist Shane Oliver said.

“That said, I don’t see it altering the likelihood of further RBA easing as on a trade weighted basis, it’s still in the range of the last few years and the threat to Australian growth from Tariff Man far outweighs any upside risks to inflation.”

The renewed Australian dollar sell-off is a red flag for the Australian economy.