Market Musings: Cross-Check: AUD/EUR - Shaky Foundations
AUD/EUR is well off last year’s cyclical highs (up around 0.70) and has tracked in a fairly tight ~4% range centered on ~0.64 since mid-October. Over the period ahead, we think the EUR can relatively outperform the AUD. We see AUD/EUR edging down towards ~0.60-0.62 over coming months, and based on our read of the evolving trends we believe any intermittent moves above ~0.65-0.66 shouldn’t be sustainable.
Our outlook is underpinned by a few factors: • Growth expectations & China
Measures put in place across the Eurozone at the end of 2022 to counter the squeeze on households and businesses from the energy crisis have unwound a lot of the acute downside growth risks/deep recession fears that had weighed on the EUR. Indeed, the latest Eurozone business PMI data indicates that activity remains resilient in early-2023. This suggests consensus growth expectations for the Eurozone may continue to be revised higher, albeit from low levels.
At the same time, ongoing rate hikes by the RBA point to a sharp slowdown in Australia, with recession risks rising with every rate rise given the burgeoning cashflow hit to the indebted household sector. Yet, consensus growth expectations for Australia have barely moved since late last year. In our judgement, this may not last too much longer (see Navigating the minefield, 16 February). These diverging trends point to relative growth expectations turning in favour of the EUR.
Externally, while China’s reopening should be a net benefit for both the Eurozone and Australia, the rebound in China’s domestic/services sectors is likely to be larger and more pronounced. This was the pattern that unfolded in other economies as they emerged from COVID lockdowns, with spending by consumers taking off. Arguably, the Eurozone has stronger linkages to this side of China’s economic story, with Australia more geared towards construction/infrastructure spending and commodity demand. As such, we think there could a larger relative tailwind for the EUR.
• Policy pulse & interest rate differentials Similarly, relative interest rate differentials, which in our mind, are already pointing to a lower AUD/EUR, may become more supportive for the EUR. The ECB has lagged the RBA in terms of speed and scale of its rate moves so far this hiking cycle, but we believe it may end up doing relatively more. In our opinion, the ECB appears more likely to cyrstalise the markets lofty interest rate expectations than the RBA. On the one hand, the Eurozone economic resilience and broadening price pressures point to further aggressive steps by the ECB over coming months. By contrast, we continue to think that while the tough talking RBA has more work to do near-term, we doubt it will end up raising rates as far as markets are now factoring in given signs the labour market is starting to soften, the unfolding downturn in housing, outlook for household spending to slow materially on the back of the large jump in mortgage rates, and headwinds for wages stemming from the mix of weaker activity and more labour supply due to reopened international borders. In contrast to current market pricing looking for the RBA cash rate to peak at ~4.25% later this year, we see the policy rate topping out at ~3.85-4.1%. • Valuations The EUR remains undervalued on a number of metrics (i.e. Purchasing Power Parity, Real Effective Exchange Rate basis). The coordinated policy response during COVID, and efforts to tackle the energy crisis stemming from the Ukraine war, indicate that there is now greater unity among Eurozone nations. This is a medium-term positive that should provide comfort for investors that may have had lingering concerns about the Eurozone’s viability. And when combined with relatively more attractive asset valuations, we expect this to support capital inflows, and the EUR's longer-term recovery.
Peter Dragicevich
Currency Strategist - APAC
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