-AUD rises after solid labour report, on signs of trade war detente.

-AUD jobs growth tops 44k, unemployment holds steady in August.

-But analysts say it may not be enough, "trade war" more important.

© Taras Vyshnya, Adobe Stock

The Australian Dollar extended gains Thursday after official data showed the economy creating new jobs at a rapid clip during August and as markets continued to serenade signs of a detente in the U.S. "trade war" with China.

Australia's economy created 44,000 new jobs during August, more that reversing the upwardly-revised contraction of -4,30 during July, which was far ahead of the consensus for employment growth of 16,500.

This saw the unemployment rate hold steady at 5.3%, in line with market expectations, despite a 0.2% increase in the so-called participation rate that boosted the number of individuals who are classified as unemployed.

"Flat hours worked suggests we should be cautious about getting too excited by the 44k gain in employment. However, the ongoing decline in underemployment, particularly in Victoria, is something we are watching closely as it could be signalling a turning point for wage inflation," says Justin Smirk, an economist at Westpac.

Currency markets care about the labour data because of the influence that changes in unemployment and wages can have on inflation, in that lower unemployment and faster wage growth means greater demand within an economy and higher inflation further down the line, which is important for questions around interest rates.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"The Aussie dollar’s dip under US71 cents this week provided great fodder for newswires, as it printed lows since February 2016. But the more telling story is probably how little time it spent at such lows and that it is now little changed over the week, close to 72 cents," says Sean Calllow, a currency strategist at Westpac.

Above: AUD/USD rate shown at daily intervals.

The AUD/USD rate was quoted 0.23% higher at 0.7177 Thursday after having notched up a 1.02% in the previous session, while the Pound-to-Australian-Dollar rate was 0.32% lower at 1.8132 after declining 0.70% Wednesday. Both rates have advanced in 2018, rising 8% and 5.4% respectively.

Above: Pound-to-Australian-Dollar rate shown at daily intervals.

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Interest Rates: Not the Only Game in Town

Australia's currency has already been badly bruised this year because 2018 changes in the global interest rate landscape have created an incentive for traders to sell the Antipodean in favour of buying the US greenback, Canadian Dollar and other currencies.

This was after it became clear the Reserve Bank of Australia will likely keep the Aussie interest rate at its current record low of 1.5% for a some time to come, while the Federal Reserve and others have continued to raise their own rates.

"Today’s employment report showed a solid set of numbers," says Kristina Clifton, an economist at Commonwealth Bank of Australia. "We expect above trend GDP growth over the next few years. This growth should help bring down the unemployment rate even further. A tightening labour market means that wages and inflationary pressures will pick up."

The Aussie has long enjoyed support from interest rates that were typically higher than those elsewhere in the developed world, although it no longer has any interest rate advantage over the US and Canadian Dollars, while the UK-Australia yield gap is also narrowing now the Bank of England has raised interest rates twice in the last year.

Clifton and the broader market expect the Reserve Bank of Australia begin lifting its interest rate in late 2019. However, for the Australian Dollar and especially in the short term, the global risk environment may be more important.

"With the Australia-US two year bond spread continuing to widen in favour of the USD, it is easy to make the case AUD/USD has plenty more downside. However, in our view, too much weight is given to interest rate spreads," says Joseph Capurso, a currency strategist at Commonwealth Bank of Australia. "Modelling by ourselves and the Reserve Bank of Australia continues to suggest that commodity prices are more important than interest rate spreads. And that the Australian Dollar might be oversold currently."

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"Trade War" Resolution Most Important

Australia's Dollar was boosted Wednesday when the People's Bank of China injected further stimulus into the domestic financial system and the Wall Street Journal reported that U.S. officials have sought fresh talks with Chinese counterparts over the tariff fight between the world's two largest economies.

This helped the risk-sensitive and China-exposed Australian Dollar onto the front foot, with gains then cemented by Thursday's solid labour market report, although it remains to be seen whether the currency can sustain its recent gains.

"The sharpest bounce in AUD/USD’s nascent recovery this week came on news that the US was willing to discuss trade policy with China before imposing further tariffs," Westpac's Callow adds. Assuming no sudden deterioration in the mood and with rates markets already pricing a 75% chance of 2 Fed rate hikes by year-end, risks on AUD/USD look to be tilted higher in the week ahead. Trade above 0.73 though might require a real breakthrough in trade talks, not just their existence."

A resolution of the "trade war" between the US and China is crucial for the Aussie given the former is Australia's largest trading partner and the Antipodean currency is underwritten by exports of commodity goods, prices of which are all highly sensitive to sentiment toward the world's second largest economy.

President Trump has announced the intention to impose tariffs on Chinese exports worth a total of $250 bn, although the levies on $200 bn of this number are yet to actually be introduced. Trump said at the weekend he is ready to move forward with the tariffs but that whether he does or not will depend on actions from the Chinese side.

As things stand, the Wall Street Journal report of fresh talks between both parties should be a significant positive development for the Australian Dollar, but some are not getting their hopes up just yet. Westpac's Callow wants to see talks making progress before getting excited, while others are of the same mind too.

"China was burned in May when Mnuchin appeared to have stuck deal under which China would buy more US goods. Trump abandons agreement and since then, US Treasury not seen as key by Chinese negotiators. Call me skeptical," says Marc Chandler, head of currency strategy at Brown Brothers Harriman.

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