-Buy AUD now that risk appetite is improving says Saxo Bank.

-AUD/USD rate set to grind higher over the medium term.

-Commerzbank forecast AUD/USD to rise, GBP/AUD to fall.

© Greg Brave, Adobe Stock

The Australian Dollar is primed for a recovery against the US Dollar over coming months, according to strategists at trading firm Saxo Bank, who are advocating that clients take advantage of recent weakness and buy the exchange rate.

Their call is based largely on the observation that global risk appetite may be turning for the better, following several months of deterioration, and that this will be good for the Antipodean currency because of its sensitivity to changes commodity prices and the market's tolerance of risk.

"Global risk appetite is improving. Our Global Risk Indicator appears to be moving back into positive territory for now after getting mired in the negative since early February – and within the G10, AUD is the classic proxy for risk appetite," says John Hardy, chief currency strategist at Saxo Bank.

The Aussie has always been sensitive to commodities given exports from down under are predominantly comprised of industrial metals, energy and other raw materials. Prices of these goods, and therefore the Aussie, are heavily influenced by the ebb and flow of expectations for the global economy.

And given its position as the world's largest consumer of raw materials, prices are particularly sensitive to economic developments in China, which has been under the cosh of late given President Donald Trump's "trade war".

"Iron ore prices have jumped again, up some 20% from the range this spring and despite all of the trade war rhetoric. This is Australia’s largest single commodity export, most of it going to China. If China is set to launch another round of stimulus to stave off the risk of its recent deleveraging attempts leading to a hard landing, Australia’s currency would benefit from the injection of fresh cash and mining activity," Hardy adds.

Iron ore prices fell sharply from around $75 at the turn of the year, to a low of $61 by the end of the first quarter, throwing another curveball at the Australian Dollar at the same time as it was under increasing pressure from a deteriorating domestic interest rate outlook. Prices stablised during the second quarter, before rising back toward the $70 level in July.

Increasingly stringent Chinese regulation of steel production was seen behind much of the earlier slump. President Trump's apparent and spiralling trade conflict with China has had little impact on the market to date, despite that it could eventually pose a challenge to the world's second largest economy.

"The long term downside risks to Australia include the eventual risk that tightening lending standards will deal a blow to economic growth via a traditional credit crunch, but this risk could be beyond the horizon of a short- to medium-term change of attitude for the better on the Aussie’s prospects," says Hardy. "We enter half a position here at the 0.74225-50 area with a stop below 0.7325 and another half above 0.7500 on a daily close above that level."

Hardy and the Saxo Bank team are targetting an eventual move back up to the 0.77 level for the AUD/USD rate and have said they will add to their position if and when the exchange rate moves back above the 0.75 level. Other analysts are also betting on an equally steep recovery for the Australian Dollar, although their rationale has more to do with the domestic story than it does international risk appetites.

"A strong US dollar, which is being supported by gradual Fed rate hikes, should keep AUD-USD at weak levels in the short term. However, the AUD will begin to appreciate at the end of 2018, as the market will then increasingly speculate that RBA will raise its key interest rate," says Antje Praefcke, an analyst at Commerzbank. "In the course of 2019, the slowing pace of interest rate hikes by the Fed and a weaker USD as a result of this suggest that the upward trend in the AUD-USD will continue."

The Reserve Bank of Australia (RBA) has held its interest rate at a record low of 1.5% for two years now, citing below-target inflation and a debt laden household sector that it says is ill-equipped to handle the pressures of higher borrowing costs given years of weak wage growth. Markets do not see a change in policy coming until at least the middle of 2019.

Australian inflation has remained below the midpoint of the RBA's 1% to 3% target for much of the last six years. Only briefly has the consumer price index rise above the 2% handle since 2012, albeit on multiple occasions, before slipping back beneath the all-important threshold soon after.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies significantly because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"Since we expect the growth outlook to remain positive as well, despite increased risks for global trade, we see room for an increase in interest rates already this year," Praefcke adds.

The Aussie has long enjoyed support from interest rates that were typically higher than those elsewhere in the developed world, although it no longer has any interest rate advantage over the US and Canadian Dollars, while the UK-Australia yield gap is also narrowing now the Bank of England has raised interest rates twice in the last year. As a result, the Australian Dollar has fallen against many of its rivals in 2018,

Praefcke and the Commerzbank team forecast the AUD/USD rate will rise back to 0.80 before the end of 2018 and that it will climb to 0.85 over the course of next year. They also predict the Pound-to-Australian-Dollar rate will fall to 1.65 by year-end before dropping to 1.61 in 2019.

The AUD/USD rate was quoted 0.09% lower at 0.7419 Thursday while the Pound-to-Aussie rate was up 0.21% at 1.7378. The Aussie was also quoted lower against all other developed world currencies barring the New Zealand Dollar.

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