AUD undervalued at current levels says INGRBA not done hiking says UBSUpcoming hikes can boost AUD says ING, UBSDisappointing Chinese growth 'in the price'

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The Australian Dollar has fallen against nearly all its major peers during 2023, but a better performance awaits into year-end say some analysts, noting the Reserve Bank of Australia will hike interest rates again and that the negative impacts of Chinese growth disappointments are peaking.

AUD weakness has therefore been driven by a combination of 1) underwhelming Chinese economic data that suggests the country's post-Covid rebound has run out of steam amidst a global economic slowdown and weak domestic demand and, 2) the Reserve Bank of Australia's apparent reluctance to pursue higher interest rates.

"The Australian dollar has been the worst-performing G10 currency in the past month, as it faced a combination of external headwinds coming from another round of Chinese growth repricing and the recent risk-off environment, as the two holds by the RBA cooling off domestic rate expectations," says Francesco Pesole, FX Strategist at ING Bank.

The Aussie Dollar fell after the central bank said on August 01 it would keep interest rates unchanged as previous hikes were having an effect on the economy and it wanted more time to study incoming data before acting again.

"AUDUSD has declined more than 2% since the RBA kept the cash rate unchanged at 4.1% on 1 August despite retaining its tightening bias," says Dominic Schnider, a strategist at UBS.

The pause was largely expected but the guidance was interpreted by market participants as being on the softer side as it gave no clear indication that further interest rate hikes were highly likely, leading to a softer Australian Dollar and Aussie bond yields.

"We maintain the RBA's job is not done, as projections of a return to the top of its inflation target by late 2025 are stretching its credibility too far, in our view. Job market strength in 2H23 will be key to watch," says Schneider.

UBS still sees scope for another 25bps hike from the RBA, in turn supporting the Australian dollar as the Fed has likely reached peak rates.

"So, we still recommend selling the downside in AUDUSD (at or below 0.66) and now also advise going long AUDSGD," says Schneider.

Strategists at ING say in a new research briefing they "disagree with markets' expectations that we have seen the peak in RBA rates, and expect at least one more hike," and this should help a recovery in the undervalued Aussie dollar.

Robert Carnell, Regional Head of Research for Asia-Pacific at ING, says there has been only a modest slowdown in the Australian economy, and most of the decline in inflation so far owes to base effects which are turning less helpful.

The run-rate for month-on-month inflation meanwhile remains much higher than is consistent with the RBA's inflation target, says the analyst.

Above: Australia's labour market is too 'tight' for inflation to fall as fast as the RBA is optimistically predicting. Image: ING.

ING pencils in at least one more hike, possibly in September or maybe waiting for the quarterly inflation numbers which will be known by the November meeting, and quite possibly two.

That would take the cash rate target to 4.35% with an upper risk of 4.6%, suggesting the market will have to raise expectations for Aussie rate hikes, which can support AUD.

"If we are right that the US Fed has finished tightening, then this could see some outperformance of the AUD into year-end," says Pesole.

Above: The Australian Dollar is undervalued shows ING's studies.

Pesole adds that AUD's sensitivity to pro-cyclical trades and the shape of the yield curve, as well as its pronounced undervaluation, put it in a good position to potentially outpace other G10 peers in a multi-quarter USD decline.

Regarding China, he says the evidence suggests much of the bad news is already in the price.

The Aussie took another leg lower on August 08 after Chinese trade data came in well below analyst expectations and revealed a 10% slump in imports from Australia.

Analysts say stimulus from authorities can reboot the economic growth story, and offer support to the Aussie Dollar, but thus far all efforts have proven lacklustre and have had little lasting effect.

"The Chinese growth disappointment factor is now largely priced into AUD, which could ultimately limit the scope for further downside. Incidentally, we estimate that AUD/USD remains around 18% undervalued in the medium term, according to our real BEER model mis-valuation results," says Pesole.

He says the domestic picture will also improve for AUD, as the RBA may well have to hike again despite the market’s flat rate expectations.

"The monetary policy story could potentially come through as a positive factor at a time (September, for example) when USD resilience hasn’t abated yet, meaning an RBA-driven bullish pocket for AUD could initially be mostly mirrored in relative strength against other pro-cyclical currencies rather than on AUD/USD," says Pesole.

ING forecasts AUD/USD to rebound back to the June and July 0.69 peaks before year-end, and then find more support above 0.70 in the first half of 2024.