Oil, gas prices riseOn expectations for additional Russian sanctionsAnd easing of Shanghai lockdownBut China remains precariousWhich could cap AUD strength

Image © Adobe Stock

2022's best performing major currency - the Australian Dollar - has found some near-term buying interest again amidst another pick up in commodity prices, although concerns over strict Chinese Covid lockdowns will likely hamper any meaningful rallies.

Crude oil and gas prices are up by over 2.0% on April 12, a rally that is met with a jump in the Australian Dollar and confirms the currency's positive relationship with this asset class.

Brent crude is up 2.20% at $100.00 a barrel and the various natural gas contracts rising in the region of 1.50%-2.30%.

The Australian Dollar is a 'commodity currency' that derives support from Australia's trade surplus which is largely a result of the export of commodities such as iron ore, coal and natural gas.

The tick higher in the Australian Dollar - by 0.36% vs. GBP and 0.30% vs. USD - extends a trend of outperformance that has been in place since the outbreak of war in Ukraine, making it the best performing currency of 2022.

Above: AUD is the best performing major currency of the day.

The Pound to Australian Dollar exchange rate trades at 1.75, the Australian Dollar-U.S. Dollar rate at 0.7428. (Set your exchange rate alert here).

Oil and gas prices are trading higher on the day amidst reports the European Union is drafting proposals for an EU oil embargo on Russia in the wake of its invasion of Ukraine, some foreign ministers said on Monday.

And expectations for harsher measures will grow in the wake of reports of the potential use of chemical weapons on Ukrainian soldiers around Mariupol.

"Swings in oil prices and renewed USD strength could keep the AUD, NZD and CAD, together with the NOK and SEK quite erratic," says FX Strategist Roberto Mialich with UniCredit.

Market analysts are also attributing some of the oil price jump on news of a partial easing of Covid lockdowns in Shanghai, which could hint China could be moving away from its zero-covid policy in the face of the highly transmissible Omicron variant.

Some 25 million people in Shanghai were in the second week of a strict lockdown after a surge in Omicron cases, but authorities said some restrictions would be eased starting Monday.

But looking at the details of the 'easing' reveals controls will continue to be strict; "appropriate activity" will only be allowed in some neighbourhoods where there have been no positive cases for at least two weeks.

Regardless, what happens in Shanghai and China in general will have a bearing on the Australian Dollar given the importance of the world's number two economy for Australian exports and broader investment sentiment.

"A positive AUD story increasingly looks priced to perfection," says Paul Robson, Head of G10 FX Strategy at NatWest Markets.

Robson says he is not looking to row against Aussie Dollar weakness given the outlook for broad market sentiment has softened in recent weeks.

Global growth concerns have risen over the past week as investors fretted about the worsening Covid situation in China that promises to slow domestic demand and therefore economic activity.

China's economy is now of a size that its performance can impact global dynamics.

"The series of lockdown since early March including Shanghai will likely lead to worsening of all the “triple challenges” that China is facing, namely shrinking demand, disrupted supply and weakening expectations," says Peiqian Liu, China Economist at NatWest Markets.

NatWest sees more downside pressures on China’s GDP growth in the first and second quarters of 2022.

"The lockdown will put more downside pressure to domestic economic activities from manufacturing to services. The services sectors will be harder hit by the full lockdown measures," says Liu.

NatWest revise their annual real GDP forecast for China to 4.7% year-on-year and see more challenges for authorities to achieve its annual growth target of "around 5.5%" with current policy settings.

Above: "China’s real GDP growth and GDP targets" - NatWest Markets. Source: CEIC, Government Work Reports, NatWest Markets Calculations.

"Given that China has rarely missed its annual GDP targets in the past few decades, we think the policy response will likely become stronger to offset some downside pressures," says Liu.

"Fiscal and monetary policy easing are needed but will not be the only policy levers," she adds.

Those watching the Australian Dollar should be aware that any unexpected and significant support from authorities could offer the currency upside support.

"In the light of the increased growth headwinds, more policy support, particularly for households, will likely be needed to stabilise the growth momentum of the Chinese economy," says economist Sophie Altermatt at Julius Baer.

According to a recent report in the China Securities Journal, China is likely to cut banks’ reserve requirement ratio in the second quarter to stabilise the economy.

Premier of the State Council Li Keqiang also said last month that China will step up support using monetary policy tools at an appropriate time and consider other measures to boost consumption

We look for further measures to be announced by authorities as they grapple the implications of the latest Covid outbreak and lockdowns.