- AUD rally to cool says model

- But still no conviction to sell AUD

- RBA's WE programme gives AUD an edge over NZD and CAD

Image © Greg Brave, Adobe Stock

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Foreign exchange strategists at Westpac have told clients that they are increasingly cautious on the Australian Dollar's ability to outperform its peers, noting that much of the good news that has pushed the currency higher has been absorbed.

"The model finally cools a touch on AUD prospects, trimming its exposure to 10%," says Richard Franulovich, Head of FX Strategy at Westpac, referring to the bank's custom FX forecasting system.

Despite a reduced enthusiasm for the Aussie Dollar, Westpac do caution that the model is not yet ready to prompt for the currency to be sold.

"Australia’s strong external accounts and the positive global risk mood account for a good part of the model’s AUD enthusiasm and both are still in place," says Franulovich.

The Aussie Dollar's rally has been impressive, with gains of 4.0% recorded against the Pound over the course of the past month with a 3.0% gain recorded against the Euro and a 8.50% gain against the Dollar.

The advance in the currency is most typically explained as being due to the rally in global equity markets and commodity prices, to which the Australian Dollar is linked. Because Australia is a significant exporter of raw materials, the price of commodities such as iron ore, coal, oil and natural gas in turn have an impact on the country's foreign exchange earnings.

But, the Australian Dollar has also outperformed its commodity currency brethren too - the NZD and CAD are both at a loss against AUD, and the reason for this outperformance gives a good clue as to why the Aussie is so hot.

"AUD, NZD and CAD have diverged sharply in recent months, the outperforming AUD leaving NZD and especially CAD in its dust," says Franulovich. "These trends have been consistent with large macro divergences that have formed between Australia, New Zealand and Canada. Notably, the RBA has been far more cautious on the QE front than either the RBNZ or the BoC."

Quantitative easing (QE) has been introduced by the Reserve Bank of Australia, Bank of Canada and Reserve Bank of New Zealand to different degrees to support their economies through the covid-19 crisis.

Data however shows that the size of the QE programmes differs greatly: the RBA has bought a total of $A51bn (2.5% of GDP), the RBNZ has purchased $NZ15bn (4.8% of GDP) while the BoC has bought $159bn (7.5% of GDP) according to Westpac.

The implication here being that the smaller the relative size of quantitative easing programme, the better supported the currency: we assume this also applies when comparing Australia to the Eurozone, U.S. and UK where central banks are engaged in open ended quantitative easing.

The Aussie economy is also better placed than many following the covid-19 outbreak: "Australia’s GDP is expected to shrink less and iron ore prices have been notably more robust," says Franulovich, referring to the country's major export.

However, looking ahead, Westpac reckon the good news is now largely in the price of the Aussie Dollar, meaning any further advances could be hard to come by.

"This is all in the price," says Franulovich, "this leg of AUD outperformance is arguably now mostly in the rear view mirror."

Economies are rapidly exiting lockdown and this should afford the rest of the world the ability to catch up on Australia's relative outperformance, while we also question how much further stock markets can rally as the so-called value stocks have already largely closed the gap on where they were before the February-March market meltdown.