© Taras Vyshnya, Adobe Stock

- The 2019 year will be kinder to the Aussie says ABN Amro.

- As RBA hikes and others pause, lifting AUD exchange rates.

- AUD/USD to recover 2018 loss as GBP/AUD declines gently.

The Australian Dollar retreated further from earlier three-month highs in the final session of the week, placing it on course to book a sizeable 2018 loss, but the New Year will be kinder to the Antipodean currency according to ABN Amro.

Analysts at the Dutch lender are banking on a turnaround for the Aussie in 2019 as the global environment becomes less of a burden for the currency and the Reserve Bank of Australia (RBA) interest rate outlook improves.

"We expect a higher Australian dollar in 2019, largely because of a rise in Australian yields," says Georgette Boele, a currency strategist at ABN. "We expect higher inflation and strong economic growth for 2019 and 2020. Therefore it is likely that the central bank will start a tightening cycle in the course of 2019."

Boele projects the RBA will raise its interest rate by 25 basis points on two occasions in 2019 and that it will follow up with another two hikes the next year. If right, then ABN's optimistic outlook for the Aussie could prove well founded given 2018's deterioration in the domestic rate outlook played a key role in the Aussie's losses during early 2018.

The Australian Dollar has declined by more than 7% against its U.S. rival in 2018 after the RBA signalled it will likely keep its cash rate at the current record low of 1.5% for a while yet, as the Federal Reserve (Fed) continued to lift its own interest rate unhindered.

Above: AUD/USD rate (orange) and U.S.-AU 2-year yield spread.

Currencies like the Pound have also made headway against the Aussie, as the Antipodean bond yield advantage over others has diminished throughout the year not only because of RBA policy, but also due to concerns about the impact the U.S.-China trade war could eventually have on the Australian economy.

The relationship between yields in the U.S. and UK as well as their respective exchange rates have followed a very similar pattern in 2018, although the policy outlook for central banks in both areas is questionable for next year.

The Federal Reserve is expected to slow the pace at which it raises rates in 2019 and there are significant uncertainties over whether the Bank of England will be able to deliver against market expectations for at least one rate hike.

As a result, if Boele proves right about the Aussie inflation and interest rate outlook, price action in the bond market could shift so that it then supports a recovery of the Antipodean currency at some point over the next 12 months.

That could mean losses for the Pound-to-Aussie and AUD/USD rate.

"US Treasury yields are currently peaking and are expected to move slightly lower in 2019, and after the Fed stops hiking the 2y US Treasury yield will probably also decline," Boele adds.

Above: GBP/AUD rate (orange) and GB-AU 2-year yield spread.

"We find it hard to imagine that the Chinese authorities will let the yuan drop in an uncontrolled manner. Moreover, the Chinese authorities will probably take steps to shield the economy from the impact of important tariffs and will support the economy via stimulus. A recovery in the yuan will support the Australian dollar across the board," says Boele.

The ABN Amro team is eyeing scope for the Australian Dollar to receive an additional boost next year from China's attempts to protect the Renmimbi from the effect of President Donald Trump's tariffs on exports to the U.S.

Trump's so-called trade war with China has destabilised markets and hurt currencies that are either sensitive to changes in the Chinese economic outlook, or developments in investor risk appetite. The Aussie is one such currency.

China's Renmimbi, with which the Aussie is closely correlated, spent much of the current week on its front foot after Presidents of the world's two largest economies claimed to have reached a truce at the G20 summit.

Trump says he will delay for 90 days, an increase in the tariff rate levied on $250 billion of Chinese goods imported into U.S. each year. China is supposed to buy more U.S. agricultural goods in return and both countries are to enter talks aimed at resolving differences over trade policies.

But the market has good reason for significant doubt over whether the truce can hold for long. Seemingly apparent differences between leaders' perceptions of exactly what was agreed at the weekend were originally the cause of doubt.

However, fears for the embryonic truce have grown since Canada's detention of Huawei's CFO, and China's subsequent objection, on Thursday. The Aussie will be sensitive to developments in the trade war saga for as long as it goes on.

"Speculators hold substantial net-short Australian dollar positions. If sentiment towards the Australian dollar would improve as a result of somewhat stronger than expected Australian macro-economic data, short covering will send the Australian dollar flying higher especially versus the US dollar. This is our base scenario," says Boele.

Boele and the ABN team say the AUD/USD rate should finish 2018 around 0.74 and that it will then climb all the way back up to 0.82 before year-end 2019.

They predict the Pound-to-Aussie rate will rise by a fraction to 1.78 before the end of 2018 but that it will then decline to 1.76 in 2019.

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