- AUD rally is sustainable says Morgan Stanley

- RBA has reached its limits

- Easing of USD shortage to aid AUD recovery

- Aus should benefit on Chinese economic recovery

Image © Robyn Mac, Adobe Stock

- Spot GBP/AUD at the time of writing: 1.9911

- Bank transfer rates (indicative): 1.9226-1.9365

- FX specialist rates (indicative): 1.9650-1.9745 >> More information

The Australian Dollar's coronavirus-linked decline is likely over say Morgan Stanley, who sees the currency outperforming as it catches the coattails of the Asian-lead recovery from the coronavirus crisis.

The call comes as the Australian Dollar enters a tentative recovery pattern and appears to be putting a floor under the sharp declines of early 2020, with gains coming alongside an improvement in global risk sentiment amidst growing confidence that the worst of the corona pandemic has now passed.

In a recent client note Morgan Stanely says the Australian Dollar "has further upside to go", and that their conviction is driven by four factors.

According to the Wall Street bank, the first driver will be the removal of the Reserve Bank of Australia (RBA) as a source of downside. The RBA has now slashed interest rates to their 'lower bound' at 0.25% meaning any further rate cuts are now unlikely.

The Aussie Dollar lost value as the RBA cut rates through 2019 and into the coronacrisis of 2020, as is typically expected of a currency when its central bank cuts interest rates.

The Australian Dollar started 2019 at 0.7046 and fell to a low of 0.5509 in March 2020, a decline of 21% that came in sympathy with the RBA slashing its base rate from 1.5% to 0.25%. The declines here contributed to a rally in the Pound-to-Australian Dollar exchange rate from 1.8096 at the start of 2019 to a March high at 2.0852, an appreciation of 13%.

Above: Monthly AUD/USD chart

But, "the RBA has largely reached its natural limits, which helps put a floor on AUD/USD," says Sheena Shah, Stategist at Morgan Stanley.

A second driver of any notable Aussie Dollar recovery would be the easing of the U.S. Dollar shortage that resulted from the market meltdown witnessed in March.

"This appears to be partially underway, allowing AUD/USD to initially rally to 0.60-0.65," says Shah.

The Federal Reserve opened swap lines with a number of global central banks - including the RBA - in mid-March to ensure it was able to directly inject Dollars into markets that required them. The Dollar remains the de facto global currency, and the move by the Fed was a timely recognition of this status.

Without the intervention the global financial system might well have frozen leading to an ever greater premium being placed on dollars.

A third driver behind sustained Aussie Dollar appreciation would be linked to global economic fundamentals: what could be a significant driver for currency markets over coming months is the speed economies emerge from the current slump.

Those countries that emerge first and fastest will see their currencies likely enjoy a premium over more sluggish rivals.

Because China was the first country to suffer the ill economic effects of the Coronavirus pandemic, they are also likely to be the first to lead the way out.

"We believe AUD/USD rallies to 0.65- 0.70 once it is clear to the market that global growth begins recovering, particularly if led by Asia (to which Australia is economically sensitive)," says Shah.

A fourth driver would potentially come in the form of improved domestic fundamentals says Shah.

"Domestic consumer deleveraging nears completion. While a long-term theme, once it becomes clear to investors that Australia's domestic develeraging is nearing completion, AUD/USD potentially continues rallying, even perhaps as high as 0.80," says the analyst.

A rally in the Australian Dollar to the extent envisioned by Morgan Stanley's strategy team would likely be replicated in other Australian Dollar crosses, suggesting that the GBP/AUD exchange rate might be reaching its high-water mark and levels above 2.0 are ultimately likely to soon slip.

Above: Monthly GBP/AUD chart

However, an obvious risk is that the current stabilisation in market sentiment proves to be a corrective bounce within a broader decline which would suggest both Aussie Dollar weakness and U.S. Dollar strength are not yet done.

Despite the recent uplift in the Aussie Dollar's value, the house view at Rabobank - the Dutch-based multi-national lender and investment bank - is that the current period of stabilisation in global markets is likely to be short-lived, which could place added downside pressures on global stock markets and the Aussie Dollar.

"Relative to their G10 peers the AUD and the NZD have been hard-hit by the events of recent weeks and the rise in risk aversion. While any bear market will be characterised by periods of consolidation and modest pullbacks, we see risk of the both the AUD and the NZD dropping again vs. the USD on a 3 month view," says Jane Foley, Senior FX Strategist at Rabobank.

Rabobank expect key international economic data releases will worsen during the current quarter, creating a risk aversion amongst investors that could weigh on the Australian Dollar in particular.