- China tightens screws on Australian imports

- Communist Party mouthpiece says moves are an act of revence

- Draws questions on future of Australia's FX earning power

- But, iron ore demand likely to remain strong for forseeable future

Image © Adobe Images

GBP/AUD spot rate at time of writing: 1.8057Bank transfer rate (indicative guide): 1.7413-1.7540FX specialist providers (indicative guide): 1.7774-1.7883More information on FX specialist rates hereThe Australian Dollar was unfazed Friday by reports warning of further imminent trade troubles with China as global factors instead set the agenda for antipodean exchange rates, although long-term risks posed by changes in Chinese commodity demand could still be significant.

Australia's Dollar rose against other major commodity currencies like the Canadian Dollar and Norwegian Krone while ceding ground to less risky counterparts, although the Pound-to-Australian Dollar rate also declined. "Australia-China trade tensions remained in the spotlight in Asia," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. "Despite the apparent escalation in an ongoing rift, AUDUSD has held above 0.7250."

Price action indicated little, if any, concern about a China Daily editorial suggesting that fresh curbs on Australian goods imports are imminent.

The state-controlled publication warned using typically bellicose language that, "Canberra should realise it will get nothing from Washington in return for its collusion in its schemes, while Australia will pay tremendously for its misjudgment."

It cited what is effectively Australia's longstanding alliance with the U.S. on foreign policy and Chinese perceptions that Australia is attempting to "contain" its economic and geopolitical expansion.

Above: Australian Dollar performance against major currencies on Friday. Source: Pound Sterling Live.

China has hit out increasingly this year about Australia's domestic political decisions, which the world's largest economy might be found describing as its own "internal affairs" if the boot was on the other foot, including Prime Minister Scott Morrisson's call for an international investigation into the initial handling of the coronavirus as well as an earlier decision to bar Chinese telecommunications firms from helping to build Australia's 5G network.

"The steadily rising escalation of political and now trade tensions is yet to impact AU to any great extent," says Tim Riddell, a strategist at Westpac.

Friday's is not the first threat to emerge from China's state controlled media, which is often viewed in the market as a ventriloquist's dummy for the government, although with the editorial appearing as Australian exporters wait to see or hear whether a de facto ban on the imports of their coal, barley, timber, wine, copper, lobster and sugar will materialise this Friday there could yet be reason for investors to pay attention.

Analysts at Commonwealth Bank of Australia say these earlier reported bans relate to only around 10% of Australia's total exports to China and suggested the curbs would likely have a negligible overall impact. They also said iron ore, which is Australia's largest export to China, is the one to be worried about and it's this particular item that might be at most risk from the Chinese Communist Party's 14th five-year plan for the country.

"The move away from Australian agriculture imports in China can be tied up with rising China-Australia trade tensions, with varying speculation as the reason why," says Belinda Allen, Senior Economist at Commonwealth Bank of Australia.

Iron ore is the foundation stone of the Australian export sector and arguably, economy, albeit a lesser one since the advent of liquefied natural gas (LNG).

But when China's commitments under the Paris Climate Accord, its new five-year plan and the increasingly confrontational tone of diplomatic relations are all taken together the Australian economy could be facing a more credible and long-term risk that leaves LNG to do a lot of heavy lifting.

"Overall we expect to see demand for commodities remain strong. However, the composition of demand will change from that of the past five years. The goal to become carbon neutral by 2060 is the prime driver behind this transition. We expect to see a gradual shift in the energy mix away from fossil fuels, as China finds a balance between economic growth and environmental goals. And we expect LNG to benefit the most," says Daniel Hynes, a senior commodity strategist at ANZ.

"What is important to note is that Australia’s reliance on the export sector for growth, particularly mining and agriculture goods, could be set for a change. A focus on high end manufactured goods and value added food exports could be a welcome shift for the Australian economy," says CBA's Allen. "We continue to maintain the view that Australia’s largest export to China, iron ore, should be unscathed due to the lack of adequate substitutes in the market. As it stands Australia is the world’s largest iron ore producer, accounting for around 40% of production, and the world’s largest exporter. And China is the world’s largest consumer."

ANZ say the committment to reach climate targets should encourage steelmakers to use electric arc furnaces (EAF) which are greener and rely less on foreign raw material.

"That would help diminish the share of steelmakers using integrated blast furnaces, which would undoubtedly have an impact on raw materials such as iron ore and coking coal. However, we don’t see a significant shift occurring. EAF steelmakers can’t compete with integrated mills on cost or output, so any such shift would require massive investment, which we think is unlikely," says Hynes.

China has committed to reaching the so-called net zero target for carbon emissions, which the iron ore burning steel industry is a big producer of, by no later than 2060.

ANZ continue to maintain the view that Australia’s largest export to China, iron ore, should be unscathed due to the lack of adequate substitutes in the market. As it stands Australia is the world’s largest iron ore producer, accounting for around 40% of production, and the world’s largest exporter. And China is the world’s largest consumer," says Allen.

Hynes adds urbanisation and higher household income should support Chinese demand for commodities in the coming years but that a "continued use of electric arc furnaces will weigh on iron ore demand."

While China's commodity demand poses longer-term questions for Australia's trade balance, and by extension its currency, for now the Australian Dollar appears more fixated on broader risk trends, exemplified by its ongoing positive correlation with the S&P 500 stock index:

Above: AUD/USD shown at daily intervals alongside S&P 500 index futures (yellow line. left axis)

"I get the feeling that many market participants are espousing narratives to justify moves rather than vice versa. I’ve heard several reasons for why the USD sold off, but none of them are compelling," says Bipan Rai, head of North American FX strategy at CIBC Capital Markets. "Given the depth of short USD views and positions out there – it feels like the sucker trade at the moment."

Australia's relationship with China and the commodity outlook was in focus Friday as investors awaited the pending result of the U.S. presidential election which, seeming to favour opposition candidate Joe Biden, has already been pre-emptively contested by the incumbent President Donald Trump.

Trump had already launched multiple legal actions over allegations of fraudulent practices before his lead in key swing states including Pennsylvania was said to be slimming on Friday. This was while opposition candidate Joe Biden had also grown his in others, risking a possibly months-long battle in the Supreme Court over this week's outcome.

“Mr. Trump is clinging onto leads in the key states of Georgia and Pennsylvania, but if Mr. Biden confirms Arizona and secures Nevada, then he will have the required 270 electoral votes to become president. No official decision has been made though and according to Nevada election officials; the count could last until November 12. Nevertheless, an unofficial confirmation in favour of Mr. Biden could be made today," says George Vessey, a strategist at Western Union Business Solutions. "If the election race becomes even more uncertain and tense, elevating the risk of social unrest, the dollar could strengthen."