- AUD outperformance to fade says Nomura

- China tensions, RBA, soft data to weigh

- But iron ore prices to limit downside

Image © Robyn Mac, Adobe Stock

GBP/AUD spot rate at time of publication: 1.8150Bank transfer rates (indicative guide): 1.7520-1.7648FX transfer specialist rates (indicative guide): 1.7725-1.7990Learn more about FX transfer specialist rates hereForeign exchange strategists at a major investment bank have this week told clients they have downgraded their stance on the Australian Dollar to neutral, observing that RBA policy, China tensions and a weak recovery from the covid-19 crisis will provide headwinds.

However, strategists at Nomura say that robust iron ore prices should provide some ongoing support for the Aussie Dollar which should provide some downside protection as other once-positive drivers start to bite.

"We have turned neutral on AUD, having been positive for several months," says Jordan Rochester, FX Strategist at Nomura, in a weekly briefing note to clients.

Nomura list the following factors for their bearish shift on the currency:

1) continuing Australia-China tensions and fresh negative stories in Chinese media,

2) a more-dovish-than expected RBA post-meeting press release on Tuesday, and

3) a far-weaker than expected Q2 GDP print on Wednesday as headwinds.

As a result in the downward shift in sentiment on the Aussie Dollar, Nomura exited a trade that sought to take advantage of further strength in the currency against the Yen.

The call by Nomura comes as the Australian Dollar edges higher against the British Pound which is being tipped by analysts to run into headwinds as Autumn delivers Brexit trade negotiation tensions and weakening data. The Pound-to-Australian Dollar exchange rate is quoted at 1.8152. The U.S. Dollar-Australian Dollar exchange rate is meanwhile quoted at 0.7275, having fallen for much of September in the face of a broader USD comeback.

The full cost of the coronavirus containment effort was laid bare last week after official data showed it had pushed Australia into its first recession for decades.

Australia's economy shrank -7% in the second quarter, the Australian Bureau of Statistics said, building on a -0.3% decline from the opening months of the year and when consensus was looking for only a -6% fall.

The economic contraction pushed Australia into its first recession since the early 1990's following that followed government mandated closure of the economy that was intended to slow the spread of coronavirus.

"Nominal GDP growth, as measured by incomes fell 7.5%, the largest decline on record. The annual rate fell from 3.1% in the March quarter to -5.8% in the June quarter, also the weakest on record, and the first annual decline in nominal incomes since 1991," says Besa Duda, chief economist at St George Bank. "Given the lift in COVID-19 cases in NSW and Victoria over the September quarter, and the restrictions imposed in Victoria, economic growth may not return until the December quarter of the year."

The soft data will likely keep the Reserve Bank of Australia (RBA) on a cautious footing going forward and Nomura say they expect further easing to be announced by the central bank.

"This follows a more-dovish-than expected RBA post-meeting press release on 1 September and a far-weaker than expected Q2 GDP print," says a briefing note from Nomura. "We have raised our probability of further RBA accommodation to 50%, notably higher than a few weeks ago. Any new accommodation would likely focus on lowering borrowing costs further, and in a way that minimises harm to banks."

The rule of thumb in foreign exchange is that increasing expectations for central bank easing is met with a weakening in the currency that bank issues.

However, Nomura acknowledge the elevated prices of iron ore as being a factor that will likely see the Aussie Dollar supported going forward which could counteract some of the negative headwinds seen elsewhere.

Iron ore prices have risen by nearly 50% over the course of the past year, which has boosted Australia's export earnings given the commodity is Australia's largest foreign exchange earner.

The demand for iron ore has risen as China embarks on a fresh stimulus programme following the covid-19 crisis, with demand likely to grow in response to the significant damage caused by floods over recent months. Meanwhile supply disruptions in Brazil has left Australia with greater market share.

Prices have been supported over recent weeks by heavy congestion at major Chinese ports which has slowed imports of bulk materials including iron ore and coal, contributing to the recent price rises according to John Meyer, analyst at SP Angel.

The China Iron & Steel Association cited concerns over delays at the beginning of August, and IHS Markit say that congestion reached a significantly high level in mid-August.

According to IHS’ vessel-tracking data, iron ore imports fell 8% in August to 98.9mt from the month prior.

Coal imports fell 25% to 15.4mt over the same period, whilst bauxite purchases slumped 34% according to Bloomberg.

"Prices for steelmaking materials is likely to remain elevated whilst the high levels of congestion persist, and inventory levels at mills be further depleted," says Meyer.

* Nomura source material provided by FXwatcher.com