Roger J Kerr says the unexpected victory of the Liberal National Coalition in Australia is likely to see a number of speculative positions unwound in the FX markets, resulting in large-scale buying of the Australian dollar

The media pundits, the political opinion polls and the FX markets all “got it wrong” on the Australian election outcome on Saturday 18th May.

There was high confidence from these three parties that there would be a change of Government in Australia with a Labour win.

The unexpected and surprising Liberal National Coalition victory coming about as key electoral seats in the mining states of Queensland and Western Australia rejected the Labour policies of tax increases and climate change in favour of certainty of jobs.

The return of PM Scott Morrison to power will be a shot in the arm for financial and investment markets as they had all positioned themselves for a change to a Labour Government.

The implications for the future direction of the Australian dollar exchange rate could well be immediate and significant.

The AUD has depreciated from 0.7200 to 0.6860 against the USD over recent weeks as domestic political uncertainty combined with the escalating trade tensions between China and the US enticed speculators to short the Aussie dollar.

A large proportion of those speculative positions now seem likely to be unwound, resulting in large-scale AUD buying in the FX markets.

The political and economic landscape is arguably somewhat different today (more positive) for Australia than when the Aussie dollar bears were counting on.

The unwinding of FX market positions over coming days/weeks could well push the AUD/USD rate back above 0.7000.

A recovery in the Australian dollar should pull the Kiwi dollar up with it. However, the speculative market is not currently short-sold the Kiwi dollar in any volume, therefore the AUD has a far greater propensity to move upwards against the USD much more than the Kiwi. The NZD/AUD cross rate which had lifted from below 0.9400 to 0.9500 in the lead up to the Australian election, now seems destined to reverse back to below 0.9400.

Aussie economic positives starting to outweigh the negatives

Employment data for April in Australia released last week was not positive for the AUD as full-time jobs decreased.

The RBA has made it abundantly clear to the financial markets that they will cut their official interest rates in June or July unless employment figures increase (unemployment rate reduces).

The RBA’s meeting minutes to be released on Tuesday 21 May should provide further insights into the probability of an interest rate cut. The AUD/USD FX market has already priced-in an interest rate cut, so further AUD selling will not be wide-spread when the cut is actually delivered.

Evidence is starting to come through that the worst may be over in terms of the downturn in the Australian residential property market. House values are stabilising as the excess supply situation in the apartment markets in Sydney and Melbourne are worked through over time.  

Forecasts on the outlook for the Australian economy (and thus their currency value) which have been very gloomy over recent months may well start to improve from here.

Renewed business confidence with the return of the Scott Morrison Government and the spectacular increases in export commodity prices will start to shift the dial in terms of the future performance of the Australian economy.

The chart below aptly displays the massive divergence currently between the mining commodity prices and the Australian dollar value against the USD.

Given the close and reliable historical correlation it only seems a matter of time before the AUD exchange rate re-aligns with commodity prices that drive the Aussie economy. Australian commodity prices are nearly back to the high levels of the 2010/2011 mining boom, yet the Aussie dollar is trading at the other end of the scale. Something does not add up?

NZ economic data also on the improve

The NZ dollar may also react to some more positive economic news of its own this week with March quarter retail sales data (Wednesday 22 May), GDT dairy auction (Wednesday 22 May) and import/export trade numbers for April (Friday 24 May).

Retail sales are forecast to increase 1.1% for the quarter, lifting the annual increase from 3.5% to 4.2%.

The monthly ANZ business confidence index for May to be released next week should show some improvement on the capital gains tax U-turn by the Labour Coalition Government. However, the latest trade negotiation squabbles between the US and China will detract from the more positive mood.

US/China trade deal still on the cards

Whilst it seems that the US and China are again at odds with each other right now over trade tariffs, there remains a strong probability that an agreement will be nutted out over coming weeks in order that President Trump can grandstand a “deal” when he meets with Chinese Premier Xi Jinping at the G20 meeting in Japan on 28/29 June.

Recovering equity markets over coming weeks will provide a signal that a trade agreement is likely and thus the global GDP growth and business/investment confidence will improve in outlook.

Should this scenario play out as expected, the Kiwi dollar will be making a strong recovery from the recent sell-off from 0.6800 to 0.6520.

The NZD/USD rate would need to initially trade back above 0.6600 to break-out of its current downtrend, and then above 0.6750 to confirm a change in direction. The Kiwi dollar is under-valued once again at 0.6520 for the reasons cited above and USD exporters should not be waiting for lower levels to load-up long-term hedging to the maximum possible.

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.