The Australian Dollar has struggled to make good on pivot away from dovish policy extremes at the RBA, its home central bank. Governor Philip Lowe and company began scaling back Covid-linked asset purchases and unceremoniously ended a policy of capping the three-year bond yield. They even relented on the possibility of a rate rise next year, seemingly bowing to market pressure after insisting for most of the year that tightening will come no sooner than late 2023.
While local bond yields duly rose, the AUD/USD exchange rate slid as much as 9.6 percent against this seemingly supportive backdrop in the second half of 2021. A tepid eleventh-hour recovery in the first two weeks of December trimmed that slide to just over 7 percent ahead of the calendar turn to 2022.
Slowing growth seems to be the culprit. The cycle-sensitive Aussie peaked in May alongside the JPMorgan Global PMI gauge, a proxy for worldwide manufacturing- and service-sector performance. The downshift came as exaggerated expansion from Covid-induced lows peaked. Soaring inflation also cooled activity. Economists’ baseline 2021 global CPI forecast jumped by a staggering 10 percent in June alone, and then kept rising.
Growth will probably continue to moderate as the maturing recovery sees momentum ease while the US central bank – the Federal Reserve – clamps down on price growth. It ended the year primed to end QE asset purchases on an accelerated timetable in the first quarter, setting the stage for three rate increases thereafter (presumably to be clustered around quarterly meetings in June, September and December 2022).
This backdrop probably means that the markets have overshot in pricing in a parallel mid-year start of the RBA rate hike cycle. Australian inflation is tamer than in the US, and is expected to remain so next year. Meanwhile, the Fed will almost certainly drive global tightening thanks to the Greenback’s central role in international commerce. This means most other central banks will have the luxury of delaying normalization. Australia is no exception.
Repricing for this scenario threatens AUD/USD. Weakness may be compounded if inflation holds up even as growth slows. Price gains may be sticky as the higher cost structure is locked into contracts, and could be amplified further if the emergence of another potent Covid variant triggers new restrictions on economic activity. The policy uncertainty inherent in such a world is likely to trigger risk aversion, punishing the sentiment-geared Australian unit.
On the charting front, a bearish Head and Shoulders chart pattern on the monthly time frame may setting a longer-term top on the rise from the Covid-made low in 2020. Breaking the pattern’s neckline just under the 0.70 figure would serve as technical confirmation, implying a measured move down toward the 0.60 figure. Reclaiming a foothold above 0.7556 might neutralize the setup. A breach of 0.8184 is probably needed to make the case for lasting gains.
AUD/USD Monthly Chart
AUD/USD monthly chart created with TradingView
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