Market sentiment is likely to turn increasingly volatile as investors await the results of the UK’s EU referendum, with any signs of a vote to leave likely to put pressure on the risk-sensitive Australian Dollar (AUD).
Despite the potentially sizable market risk posed by the week’s UK EU membership referendum, risk appetite has been on the rise in recent days. With the latest Reserve Bank of Australia (RBA) meeting minutes reiterating policymakers’ general reluctance to cut interest rates again in the near future this saw the Australian Dollar (AUD) making some strong gains against rivals. Although the first quarter Australian House Price Index pointed towards a slowing in the domestic housing market this failed to particularly weigh on the antipodean currency.
Confidence in the US Dollar (USD), on the other hand, was generally muted thanks to a decline in safe-haven demand. Investors remained uninclined to buy into the ‘Greenback’ following the increasingly dovish tone taken by members of the Federal Open Market Committee (FOMC) since the central bank’s last policy meeting. With the chances of a summer interest rate hike appearing to have weakened substantially, there was little to stop the Australian Dollar to US Dollar (AUD/USD) exchange rate making continued gains.
Commentary from Fed Chair Janet Yellen did little to discourage this bearish impression, with the policymaker emphasising the need for a gradual pace of monetary tightening. As Yellen also acknowledged the downside risks facing the US economy and the negative surprise of the May Non-Farm-Payrolls report the tone did not appear overly hawkish. Thus, in spite of Brexit-based uncertainty increasing ahead of Friday’s referendum result, the ‘Greenback’ remained on a weaker footing against the majors.
The Westpac Leading Index for May offered further support to the ‘Aussie’ on Wednesday, with the measure rising from 0.14% to 0.21% to indicate an improvement in the domestic economic outlook. This would seem to suggest that the Australian economy is not being overly weakened by negative global headwinds, encouraging confidence in the antipodean currency. However, as Alvin Tan, Research Analyst at Societe Generale, noted:
‘The Australian terms of trade is still falling, and thus the fundamental path of least resistance for AUD is for further depreciation. This, plus the persistent and surprising disinflationary pressures in Australia, has kept the RBA on an easing bias, with one rate cut expected in H2 16. Monetary divergence should thus be another factor in the second half of the year for a lower AUD/USD as the Fed readies to tighten again.’
Wider market sentiment will remain the key driving factor for the AUD/USD exchange rate ahead of the weekend, particularly once the results of the UK referendum begin to come through on Friday. If the odds continue to favour a ‘Remain’ vote then the ‘Aussie’ is likely to benefit from a greater appetite for higher-yielding currencies. However, if the tide ultimately turns towards a Brexit then the US Dollar is expected to see a sharp increase in demand.
Although there will be a number of US ecostats released over the next couple of days this is expected to be largely overlooked by markets. Nevertheless, if manufacturing and housing data continues to indicate a slowdown in the US economy then the ‘Greenback’ could be dented further.
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