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The Aussie saw mixed price action in 2016 as foreign risk factors collided with some weak economic data on the Aussie home front.  What happened and what should we look out for in 2017? But before we start looking at external factors, let’s check out how the Australian economy and monetary policy played out in 2016: 

Growth and Inflation

Australia GDP and Inflation
Australia GDP and Inflation

GDP growth trended lower in 2016, starting out with an annualized growth rate of 4.00% in Q1 before sliding all the way down to an annualized rate of -2.00% by the third quarter–the first negative read since the first quarter of 2011! According to Reuters, this was likely due to a cutback in mining and manufacturing, a part of the broad trend of lower business investment (a concern cited by the Reserve Bank of Australia (RBA) in various policy statements throughout the first half of the year), down 4.00% quarter over quarter in the most recent read.

We can also see on the chart above that inflation in terms of the quarterly percentage change in the Consumer Price index continues its own slide, in a downtrend since early 2014. It’s a similar situation as New Zealand, where lower global growth and inflation (mainly commodity prices) was dragging down prices in the country, adding onto the subdued growth in domestic labour costs, also cited by the Reserve Bank of Australia as a concern in various monetary policy statements.

The drop in inflation conditions and concerns for global economic conditions prompted the RBA to take action in the form of two interest rate cuts to the Cash Rate: a surprise cut in April and a widely expected cut in August. In the chart below of AUD/USD and the Australian dollar Trade Weighted Index, you can see the big difference in market reactions to a surprise rate cut and an expected rate cut.

AUD/USD vs. AUD Trade Weighted Index

AUD/USD vs. AUD Trade Weighted Index
AUD/USD vs. AUD Trade Weighted Index

Even with two interest rate cuts, low inflation and declining growth conditions in Australia, the Aussie dollar didn’t seem to have much problem finding some buyers to keep it from falling apart given the domestic conditions.  What gives!?

First, the interest rate differential.  It’s likely that even with the two rate cuts, a 1.50% rate is still attractive versus the extremely low central bank rates from the other major currencies (with exception to the New Zealand dollar at 1.75%), especially considering that Australia’s growth rate still made it a pretty safe bet until we got the weak third quarter GDP number. So as long as the interest rate differential remains in their favor, they’ll continue to find some level of buyers against the low-yielding, poorer-performing currencies.

Second, it’s likely the China effect. According to the Australian Trade and Investment Commission’s export report on 2015 performance, China continues to be Australia’s largest trading partner at 28.8% of exports.  So when China is feeling good, Australia is a likely beneficiary, but when China is in a rough patch, well, watch out for fallout in the Land Down Under!

In 2016, China started out in one of those rough patches with fears of a slowdown growing, taking down global financial markets and commodity prices with it. The situation was so bad that the government had to ban short-selling in the Chinese equity market, and eventually decided to bring out the big guns of lowered bank reserve requirement ratios in February and various Chinese Yuan devaluations to spur economic growth.

We can see this play out in the chart of AUD/USD and the AUD Trade Weighted Index posted above, with the Aussie falling through January before finding a bottom in February after Chinese stimulus measures were announced. The following rally in the Aussie was likely on the expectation that China will grow because of the stimulus, lifting commodity prices and its spending with their trading partners. We can see this play out in two of Australia’s major export products that China buys a lot of: Iron Ore (Australia’s number one export) and Gold (sixth largest export)

Iron Ore 62% Futures vs. Australian Dollar Trade Weighted Index

AUD TWI vs. Iron Ore 62% Futures
AUD TWI vs. Iron Ore 62% Futures

Iron Ore and the AUD Trade Weighted Index move with a 76% correlation in 2016. Iron Ore bulls should thank China stimulus for the over 90% gain this year!

Gold Futures vs. AUD/USD

Gold Futures vs. AUD/USD
Gold Futures vs. AUD/USD

Gold futures and AUD/USD had a 67% correlation in 2016 with Gold leading the way in the latter half of the year.

We can also make an argument that the lowered expectations of a early 2016 Federal Reserve rate hike helped support risk-on sentiment and commodity prices, but the majority of buying support likely came from the positive sentiment on China’s outlook after the stimulus packages, drawing in buyers all the way through October and despite a couple of RBA rate cuts.

As we close out 2016, it looks like buying support for the Aussie has faded, first on U.S. dollar positive influences from the U.S. (the Trump Presidential victory and the Federal Reserve raising the Fed Funds target to 0.75%), but also on China growth worries once again as Chinese President Xi Jinping expresses openness to economic growth slowing below the government’s 6.5% target.  Combined with the weak Aussie GDP, it looks like this is enough to pull down the Aussie for a mixed 2016 performance; slightly up in terms of its Trade Weighted index (1.75% as of Dec. 28 close) but more down that up against the major currencies:

AUD Pairs 2016 Ranking
AUD Pairs 2016 Ranking

What’s Next for 2017?

Going forward, these fresh China fears should be a concern for commodities and commodity dollars like the Aussie. If these fears grow and turn into a fall in risk assets and commodity prices, look out for lower inflation in Australia, and likely more rate cuts from the RBA. And we’ve gotta keep an eye out for Aussie GDP to see if that negative quarter was a fluke or if Australia is on its way to a recession. In either case, it looks like it may be a rough start for the Aussie in 2017!

What do you think? Is Australia on the verge of bouncing back? Will global inflation pick up? Will China once again its latest round of growth concerns? Vote in the poll or leave a comment below!

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