Australian Dollar Outlook: Commodities Dominate AUD
The Australian dollar gained ground last week as turbulence from the Russian invasion of Ukraine rippled through markets.
While central banks and underlying fundamentals still have a role to play, the bigger picture could see capital flows dominate the AUD.
Trade data released during the week came in better than expected at AUD 12.9 billion for the month of January and GDP also beat slightly. The annual number for 2021 showed a growth of 4.2%.
Federal Reserve Chairman Jerome Powell confirmed during the week that they were all set for a 25 basis point rate hike at their March meeting. Although he noted that it was “too early to tell if Russia is changing the path of rates.”
The RBA, on the other hand, has indicated that it will wait for Q1 CPI data before acting on rates. They will get this data at the end of April, so it will be the monetary policy meeting in May that has the potential to change the official exchange rate.
They left rates unchanged at 0.10% at their meeting on Tuesday.
Short-term yield differentials favor the USD, but the back-end favors the AUD, with the 10-year yield spread rising to 36 basis points.
The ongoing war in Ukraine has hampered the supply of many basic products and hopes for a quick resolution of the conflict now seem unlikely. This led to dramatic upward movements in the prices of energy, industrial metals, precious metals and raw materials.
That’s all Australia exports.
Russia accounts for around 0.2% of Australian exports, as it is largely a direct competitor and owns most of the same assets. With Russia being sanctioned, this could lead to increased demand for Australia’s export volume of commodities.
Higher prices and higher export volume may not be the only tailwinds for the AUD.
Global stock index providers MSCI and FTSE have removed Russian stocks from their indexes. Additionally, rating agencies S&P, Fitch and Moody’s downgraded Russian debt to junk.
On the stock side, this means that investors holding Russian companies have now seen their investments valued at zero. There is currently no way to physically sell the shares.
On the debt side, this means that bond fund managers will not be able to buy any Russian issues and, like their stock market counterparts, may not be able to sell their existing bonds.
Russia has become uninvestable.
Global fund managers have mandates that stipulate how much of their portfolio should be invested in each asset class. Now that Russian investments in commodities are worth very little or nothing, the reweighting could lead to demand for this type of asset in other parts of the world, such as Australia.
The hurdle for the AUD is clearly the risk environment that a war creates and commodity swings can subside.
However, we have already seen that this war is not a typical risky event. Volatility looks likely to continue and a sell-off in the AUD could occur, but the fundamental backdrop remains favorable for the Aussie.