Australian dollar bashed by Morrison Government blundering

Last night the Australian dollar was bashed lower again as the US dollar bull market case firms up. More and more analysts have swung behind the MB view that DXY is up and away as US growth exceptionalism returns. To the charts:

The Australian dollar was bashed back to the 75s:

AUD was so weak against DMs, with toppy patterns against EUR and JPY as well, that we can posit that the Morrison Government’s vaccine disaster is starting to weigh on forex. Last night the issue was big news worldwide as the personality disordered PM blamed Europe for his failures. And the AUD is falling against the GBP as well, where vaccines are going swimmingly.

It makes sense. One of the key reasons for the falling EUR and the resurgent DXY is their respective vaccine circumstances, along with divergent fiscal impulses, both of which are key inputs into their growth, inflation and monetary profiles. The Aussie ten-year yield advantage over US has now shrunk to just 2bps. We should expect Australia to be judged so. Lombard:

USD gains in Q1 from position unwinds and growth outlook re-rating

 As the reopening matures, the US trade deficit shrinks and the Fed begins to consider tapering, the dollar could catch a bid

 But with seasonal weakness in April, USD is in a range. The dollar has just had its strongest start to the year since 2015. We have been bearish USD since the Fed’s Jackson Hole symposium in August last year, where Fed Chair Powell laid out the central bank’s new average inflation target policy stance. But since Christmas we have worried about the large short-USD position overhang and the risk of a USD squeeze. Usually a squeeze needs a trigger, and the rapid economic reopening, necessitating rapid growth revisions, was just that trigger. LeveragedUSD short positioning has, in aggregate, now unwound, largely thanks to a rapid flip of JPY shorts to JPY longs (there are still large asset-manager USD shorts but these positions tend to be less sensitive to FX moves and are more likely hedges against asset holdings elsewhere in the investor’s portfolio). While US growth remains much stronger than elsewhere, it is unlikely that USD will resume its fall. The chart below right plots the US vs EA year-ahead nominal growth expectations differential: the current spread is near 2pp,as high as early 2017, when EUR/USD was trading in a 1.05-1.10 range. With a growth differential like this, portfolio investment (and possibly FDI, if investors lose confidence in EA policymakers’ ability to stoke any sort of recovery) will prefer the US over the EA.

For this reason, USD is unlikely to resume its decline–in fact, the risks to the dollar are to the topside–unless the EA growth outlook improves. But with European countries now entering a third lockdown and Google mobility data for Italy already showing a reversal in the recovery, the EA reopening growth may be delayed once again. Until the EA begins to see the light at the end of the tunnel, the broad dollar is unlikely to fall.

The US’s twin deficit, currently exporting significant quantities of dollars, is likely to shrink in H2. During periods of widening twin (fiscal and current account) deficits, the dollar tends to fall (see left-hand chart above): the twin deficit is currently near 20% of US GDP (we truncated the axis in the chart above to aid legibility for the pre-Covid period); but over the next few months, the twin deficit is likely to shrink, and ,as the chart shows, this tends to coincide with periods of rising dollar.

First, the unprecedented fiscal support over the last12months is unlikely to be repeated in the next 12 (and the infrastructure bill, as a 15-year project, is a budgetary item with a relatively small immediate impact. Second, the annual US goods trade deficit is approaching $1tn, a record.But as the reopening of the US economy matures, demand for domestic goods and services will supplant current demand for imported goods. Not only will the fiscal impulse tighten; the US will be exporting fewer dollars towards the end of the year.

Furthermore, we reckon the Fed will taper asset purchases in December–and tell us about it in June.We are certainly not talking about tight monetary policy here, but the prospect of less loose policy is another reason why the dollar decline may have had its day.

It is not too often that a developed economy government is so bad that it sinks its own currency on pure ineptitude. But let’s face it, macro blundering in the era of global pandemics is very different from normal programming. The cost of bumbling is normally weighed in a few billion and covered up by the corrupt press. Vaccine failure is weighed in the outlook for many billions of dollars and there is no hiding it.

So it is coming to pass for Europe and Australia that vaccine failure is now devaluing their entire national economies.