- AUD falls after White House ups ante in US-China trade spat.

- Tariffs rise from 10% to 25%, stoking fears for Aussie economy.

- Market overlooks blowout trade surplus, bullish retail sales forecasts.

© Adobe Stock

The Australian Dollar showed its sensitivity to global trade again Thursday when it ceded ground in the wake of President Donald Trump ordering an increase in duties on imports of Chinese goods into the US, which led traders to overlook a blowout increase in the Australian trade surplus for June.

President Trump has instructed US trade representatives to increase the tariffs it levies on around $200 billion of Chinese exports, from 10% to 25%, citing China's failure to address US concerns over "unfair trading practices" that include "forced technology transfer and intellectual property theft". China has been quick to retaliate against most US tariff actions.

Fears are that a tariff fight between the world's largest economies will quickly descend into an all out "trade war" and that this will dent economic growth in all countries it touches. However, the consequences would be especially pronounced for Australia given its close economic links with China and the Aussie's positive correlation with commodity prices that tend to fall when the global growth outlook deteriorates.

“On June 18, the President directed me to identify $200 billion worth of Chinese goods for additional tariffs at a rate of 10 percent, in response to China’s decision to cause further harm to U.S. workers, farmers, and businesses by imposing retaliatory duties on U.S. goods. I initiated this process on July 10," says Robert Lightizer, US Trade Representative, in a statement. “This week, the President has directed that I consider increasing the proposed level of the additional duty from 10 percent to 25 percent."

Wednesday's move means when the latest tariffs have been introduced, the White House will have imposed levies on more than $250 billion of Chinese exports to the US, although it has threatened to target the full $500 billion of goods that China exports to America each year.

The AUD/USD rate was quoted 0.64% lower at 0.7358 during early trading Thursday while the Pound-to-Aussie rate was up 0.27% at 1.7772. The Aussie was also quoted lower against all other developed world currencies.

Meanwhile, global stock markets fell overnight and into the morning session Thursday while oil prices were lower and gold steady. The FTSE 100, an index with broad international diversification, was down 1.17% at 7,564 during early trading in London while the German DAX was 1.69% lower at 12,522 in Frankfurt.

AUD Shrugs at Blowout Trade Surplus

Thursday's price action comes despite a blowout surge in the Australian trade surplus, which rose to $1.87 bn, during June. This is up from the $730 million surplus seen back in May and almost double the consensus forecast for a surplus of $910 million.

Markets care about trade data because it provides valuable insight into real-world demand for a currency. A rising trade surplus suggests either that exports and their associated demand for a currency are rising, or that imports and their associated supply of a currency on global markets are falling. Both are typically good for a currency while a steadily narrowing trade surplus, or a widening deficit, is a neagtive influence.

The size and trajectory of a trade surplus or deficit is also important for economic growth and therefore, inflation and interest rates. This is because imports are a substraction in the calculation of GDP while exports represent a credit to the value of economic output. As a result, rising exports and, or, falling imports can help boost the economy.

"June trade surplus at $A1.873 punched through the most optimistic forecast of $A1.3b (market $A900m) with exports +3% and imports -1% (although capital goods +5%)," says Annette Beacher, chief Aisa Pacific macro strategist at TD Securities. "AUD slept through the strong report but Q2 retail sales tomorrow might be the jolt it needs."

Retail Report to the Rescue?

Thursday's trade data came just a day ahead of the June retail sales report, due to be released by the Australian Bureau of Statistics at 02:30 am London time Friday, with economists also optimistic about the prospect of a strong number here too.

Consensus is for Australian retail sales to have risen by 0.3% during June, down a fraction from the 0.4% pace of growth seen in April and May but nonetheless, drawing a line firmly beneath the weak performance seen during the first quarter.

"We see risks as skewed to the upside for the retail print, but we’d use any rally there to reset shorts. Our analysis shows that retail sales have only a temporary effect on the currency. But, importantly, we think relentless USD strength plus a likely escalation in USChina argy-bargy makes it hard to see the AUD doing anything other than underperform," says Daniel Been, head of FX research at Australia & New Zealand Banking Group.

Markets care about the retail data because it is a leading indicator of economic growth and because of the influence that rising or falling consumption can have on inflation. It is inflation that central banks are attempting to contain when they raise interest rates, and rates themselves are the raison d'être for most moves in currency exchange 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.

Reserve Bank of Australia in Focus

"The AUD lacks any catalyst to pursue a sustained move higher, not least because the domestic data flow remains uninspiring from an RBA rate hike perspective, even more so after the disappointing Q2 CPI. The global environment will continue to dominate moves. While positive sentiment should see the AUD outperform, the threat of a trade war means it is hard to bank on a sustained relief rally," says Been.

The Reserve Bank of Australia has held its interest rate at a record low of 1.5% for 23 consecutive months, citing below-target inflation and a debt laden household sector that it says is ill-equipped to handle the pressures of higher borrowing costs given years of weak wage growth. Markets do not see a change in policy coming until at least the middle of 2019.

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 raises interest rates twice in the last year.

The deterioration of the outlook for Aussie interest rates, at a time when the US Federal Reserve and other central banks are raising their own rates, has incentivised investors to sell the Australian Dollar in favour of buying Pounds, US Dollars and other currencies.

Advertisement

Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here