Australian Dollar Q4 Fundamental Forecast: AUD/USD Has Hurdles that Could be Overcome

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Australian Dollar, AUD/USD, China, RBA, Fed,Yields – Fourth Quarter Fundamental Forecast

  • Australian Dollar depreciated against the US Dollar to finish Q3
  • The bad news may be priced into AUD/USD but that could change in Q4
  • Commodities, USD, yield-spreads, Delta and China may all play a role

To read the full Australian Dollar forecast, including the technical outlook, download our new 4Q trading guide from the DailyFX Free Trading Guides!

Q3 Recap – AUD/USD Consolidates

The Australian Dollar made a new low for the year in the third quarter. Reasons for the weakness include the collapse in the iron ore price and other commodities,China uncertainty, the spread of the Delta variant of Covid-19, US Dollar strength and interest rate differentials, among other factors.

China’s Shared Prosperity Policy Continues to Impact

The Chinese Communist Party (CCP) have stipulated that the Chinese steel mills must produce less steel in the second half of 2021 than was produced in the second half of 2020. Although the iron ore price is considerably lower than the lofty heights seen earlier in the year, it is still near the highs seen through 2020. There is scope for the price to fall further but perhaps not much further.

An iron ore price near 70-80 USD a tonne changes the dynamic as other producers become unprofitable near those levels. This creates a potential floor on the price of iron ore. Australian miners have a 20 USD per tonne cost base, which is hard to replicate because of the scale of the infrastructure required.

China have cracked down on various sectors of the economy and are likely to continue to do so as they implement their ‘shared prosperity’ policy. This has the potential to de-rail confidence and risk appetite for markets, which would be negative for AUD. However, the Evergrande episode has shown that the CCP will step in when necessary to safeguard any material weakness. The worst of the regulatory scrutiny might be behind us.

Unlocking the Economy

Going into the 4th quarter, large parts of the Australian economy are in lockdown. New South Wales will be coming out of the stay at home orders in October and other states will be joining them once they have achieved their vaccination targets. When this happened in 2020, there was a considerable up-tick in economic activity.

Central Bank Actions Will have Repercussions

The Federal Reserve indicated that there will be a tapering of the amount of monthly bond purchases and that is likely be announced at their next meeting in November. US rates are not expected to move until next year at the earliest.

The RBA have tightened monetary policy in the third quarter by reducing their bond buying program from AUD 5 billion a week to AUD 4 billion. They have stated they will continue at this pace until February 2022 and that interest rates are on hold indefinitely.

Australian–US 10-year government bond yield differentials have historically had strong correlation to AUD/USD. The differential had been as wide as 18.5 basis points in favour of US yields in the third quarter, but is now approaching parity, underpinning the Australian Dollar.

The fourth quarter may have some unknown risks, perhaps emanating from China or another Covid-19 mutation, but if the Australian economy comes out of lockdown strongly, there could be supportive conditions for Australian Dollar.

Chart – AUD/USD and Australia/US 10-Year Government Bond Yield Differential

Australian Dollar Q4 Fundamental Forecast: AUD/USD Has Hurdles that Could be Overcome

Chart created in TradingView

To read the full Australian Dollar forecast, including the technical outlook, download our new 4Q trading guide from the DailyFX Free Trading Guides!

— Written by Daniel McCarthy, Strategist for DailyFX.com

To contact Daniel, use the comments section below or @DanMcCathyFX on Twitter

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