African Currency Review
USD
After starting the year on the backfoot, the USD has recovered some lost ground recently. This has reflected a combination of macroeconomic and market developments. The early-2023 resilience in the US economy and stubbornly high inflation, which triggered a sharp repricing in expectations for how high US interest rates could reach this cycle was an initial factor underpinning the USD rebound. This has since morphed into safe-haven demand as ructions across the US regional and European banking system raised concerns about the outlook for the global economy, and generated bouts of financial market volatility.
The global economy has entered a more challenging phase. The growth and financial market spillovers stemming from the very large and very fast lift in US and global interest rates implemented over the past year to help bring down rampant inflation have started to bubble to the surface. We expect more of the economic and market effects to show up over the months ahead. In our judgement, this, in conjunction with still sticky and high US inflation, and the US Federal Reserve’s ‘restrictive’ policy stance, should help keep the USD supported over Q2 2023.
However, while we believe the USD should remain firm near-term, we don’t anticipate the USD to make new highs. Indeed, the USD ‘peak’ looks to be behind us with the Q3 2022 heights not expected to be bested. Looking back, we have found that the USD has typically moved in large multi-year cycles. With the latest multi-year upswing ending, we are of the view that the USD should weaken over the next few years once the current uncertainty about the global backdrop subsides, and as other fundamentals such as growth and policy expectations continue to shift against the ‘overvalued’ USD in favour of the other major currencies such as the EUR, JPY, and CNY.
AUD
The AUD has endured a volatile start to 2023. The initial China-reopening induced optimism, which propelled the AUD higher over January, quickly gave way to a stronger USD as US interest rate expectations adjusted higher following a run strong US activity data and higher than predicted inflation. The more cautious and pragmatic guidance from the RBA following its early-March interest rate hike, suggesting it may take measured steps from here, coupled with the bouts of negative risk sentiment as stresses emerged across part of the US and European banking systems also acted to weigh on the AUD.
We think the AUD’s recent swings could be a taste of things to come. Financial market volatility looks set to continue over the next few months, in our opinion, as the aftershocks from the most abrupt global monetary policy tightening cycle delivered in several decades continue to show up in markets. At the same time, the global economy should continue to slow materially under the weight of very high interest rates which are designed to constrain activity and bring down inflation down the track. We see the AUD tracking in a $0.66-0.69 range over Q2 2023 as the crosscurrents of ongoing pockets of market turbulence, global recession fears, and stronger commodity demand on the back of the re-awakening Chinese economy play out.
Beyond the next few tricky months, our underlying view is for the AUD to edge up towards the mid-$0.70s by early-2024. We think that once the worst of the global downturn passes over Q3/Q4, signs of improving economic momentum, combined with a stronger Chinese economy, and a definitive shift in stance by the US Fed from being a rate hiking ‘inflation fighter’ to rate cutting ‘growth supporter’ should act to bring down the USD and boost the AUD.
EUR/USD
After falling below parity in Q3 2022 for the first time in ~20-years, EUR/USD has bounced back over the past few months. The EUR’s recovery has been driven by a few interconnected factors. Economically, the measures put in place across the Eurozone over late-2022 to counter the squeeze on households and businesses from the energy crisis have unwound a lot of the acute downside growth risks and deep recession fears that had weighed on the EUR. Indeed, the recent Eurozone business PMI data indicates that activity has remained resilient in early-2023. The stronger than forecast growth momentum, combined with the upswing in inflation, with core CPI hitting a new Euro-era high of 5.6%pa in February, has seen the European Central Bank raise interest rates somewhat aggressively over the past few months. On the back of a string of 50bp rate hikes the ECB has increased its policy rate from 2% in November to 3.5% in March. Importantly, despite the pockets of stress across the banking system, the ECB remains open to tightening policy further to win the battle against inflation.
Over Q2 we expect EUR to oscillate within a ~1.07-1.10 range, with the slowdown in the global economy caused by tight monetary and credit conditions, and reverberations from the abrupt tightening cycles set to generate further bouts of market volatility. But beyond additional near-term gyrations, we remain quite positive towards the EUR over a longer time horizon, and project EUR/USD to shift up towards 1.16 by year-end. In our opinion the EUR should be supported as 2023 unfolds by additional ECB rate hikes, the positive spillovers into Eurozone activity from China’s reawakening, capital inflows enticed by the EUR’s comparatively attractive valuations, the Eurozone’s large current account surplus, and the predicted downturn in the USD.
AUD/EUR
AUD/EUR is well off last year’s cyclical highs, having fallen by ~12% from its late-August 2022 peak. We think the recent run can continue and see AUD/EUR edging down to ~0.60 over Q2. Indeed, we believe that the evolving fundamental trends point to AUD/EUR tracking in the low 0.60s over 2023. FX is a relative price. Our AUD/EUR thoughts are underpinned by our predictions for various drivers to remain in the EUR’s favour. In terms of domestic activity, momentum should slow in both the Eurozone and Australia as tighter credit conditions and jump up interest rates constrain spending and investment. However, given its higher household debt burden, and stronger spillovers from housing market trends, risks are tilted to the Australian economy feeling the impacts of rising rates sooner and by more. Growth expectations for both economies have been cut, but we think consensus views for Australia could be reduced a bit further as higher mortgage costs bite.
Externally, while China’s reopening should be a benefit for both, it is important to recognise that the rebound in China’s services sectors should be more pronounced. This was the pattern in other nations as they emerged from COVID lockdowns, with spending on areas like travel, entertainment and hospitality taking off. Arguably, the Eurozone has stronger linkages to this side of China’s economy, with Australia more leveraged to commodity-intensive infrastructure investment. Similarly, relative interest rate differentials, which in our mind, are already pointing to a lower AUD/EUR, may become even more EUR supportive. In our judgement, the Eurozone’s inflation pressures, and less straight forward policy transmission mechanism mean the ECB has more work to do. By contrast, we think the RBA, who remains vocal about trying to achieve a ‘soft landing’ and keeping things on ‘an even keel’ is nearing the end of its tightening phase.
AUD/ZAR
AUD/ZAR has been in a volatile uptrend for several quarters, with the pair (now ~11.96) ~15% above its mid-2021 low. The ZAR has been buffeted by a range of forces over the past few years. South African growth has slowed sharply following its initial COVID recovery. Power cuts that have been imposed have disrupted production, while consumption has been hampered by the hit to purchasing power generated by surging inflation and upswing in interest rates aimed at bringing prices under control. South Africa’s benchmark policy rate is now 7.75%, a high since Q2 2009, after the South African Reserve Bank came through and delivered a larger 50bp hike in late-March as concerns about inflation remain entrenched. Elsewhere, the sharp swing in South Africa’s current account position, from a surplus equal to 4~% of GDP in mid-2020 to a deficit of ~2.5% of GDP on the back of rising fuel and machinery imports, has also worked to depreciate the ZAR.
We, and the broader consensus, think that the ZAR’s weak run can continue near-term as domestic economic challenges are compounded by the unfolding global slowdown and expected further bouts of volatility. Given Australia’s relatively more favourable balance of payments position (the current account surplus is ~1% of GDP), we believe this could see AUD/ZAR push higher over the next ~3-6 months. The implied consensus forecasts based on the outlook for the AUD/USD and USD/ZAR puts AUD/ZAR up around ~12.50 in Q2. But this is also predicted to be the ‘peak’, with AUD/ZAR projected to gradually drift lower over future quarters and end the year down near 12.00. We assume that once the worst of the global downturn passes and the anticipated recovery kicks into gear later this year, and as risk sentiment is bolstered by an eventual pivot by central banks to a more accommodative footing, capital inflows into emerging markets should lift. This should be a ZAR tailwind.
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Peter Dragicevich
Currency Strategist - APAC
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