Australian dollar (AUD/USD) 2023 price outlook: Aussie to soar on China's reopening and Fed pivot?
15:41, 6 December 2022
The Australian dollar (AUD/USD) witnessed a negative 2022, sliding by nearly 7% against the US dollar, owing to China's prolonged Covid lockdowns hurting domestic growth and the Federal Reserve's aggressive rate hike cycle fueling USD demand.
Eight consecutive rate hikes by the Reserve Bank of Australia have brought Australian interest rates to 3.1% as of the end of the year, pushing borrowing costs to the highest they've been in a decade and marking the fastest RBA's tightening cycle since 1989. The firm RBA rate hike cycle kept the Australian dollar from falling in other FX crosses, outperforming the Japanese yen (AUD/JPY), the euro (EUR/AUD), and the British pound (GBP/AUD). However, monetary tightening in Australia is nearing an end, as the RBA has already reduced the pace of increases and indicated a data-dependent approach going forward.
But what has been a headwind for the Australian dollar in 2022 may gradually turn into a tailwind as we approach next year.
The Australian dollar has lately benefitted from higher expectations for a Chinese economic reopening as a result of removing Covid restrictions, as well as hints of a slower pace of Fed rate rises in 2023. If these two trends continue, they may offer support for the Australian dollar, allowing it to retain a value over 0.70 compared to the US dollar and maybe approach the 0.75 zone in the second half of the year.
If China's reopening from Covid is effective, and US inflation slows as expected, causing the Fed to change its course, the second half of 2023 might be a strong positive period for the Australian dollar.
The primary negative risks for the AUD are the strong link with risky assets like as equities markets, which may see some volatility in Q1, a return of Covid in China, and higher-than-expected inflation in the US, which will keep the Fed on a hawkish stance. In this scenario, the AUD might remain below 0.70.
Now, let's delve even further into the outlook and price predictions for the Australian dollar in 2023 from both a fundamental and a technical perspective.
The Australian dollar's 2022 year in review
Year-to-date performance of the Australian dollar vs major currencies (data as of December 6th 2022) – Photo: Capital.com, Source: Tradingview
Table displaying the Australian dollar's most recent performance vs the USD, EUR, GBP, NZD, CHF, JPY, and CAD – Photo: Capital.comThe Australian dollar has had a tough year, as its value has been steadily weakening against the US dollar (AUD/USD) since April. The Aussie dollar's year-to-date performance against the US dollar was -7% as of December 6, 2022.
After reaching its 2022 high of 0.766 on April 5, the AUD/USD pair plummeted as much as 0.6170 levels on October 13, registering a 19.4% decline from the peak and just narrowly escaping a technical bear market.
The prolonged lockdowns in China, which had been strengthened just in late April, and the larger-than-anticipated increases in interest rates by the Federal Reserve, which delivered the fastest bullish cycle in its history, generated a strong buying demand for the greenback and contributed to the Australian dollar's poor performance in 2022.
Since May, the RBA has raised interest rates by a cumulative 300 basis points (or 3%) to the highest levels (3.1%) in a decade, marking the fastest annual tightening since 1989, though still relatively less than the Federal Reserve's 375bp hike cycle up to December 2022.
Risk aversion in equities markets impacted on the high-beta Australian dollar, although a hawkish RBA shielded the AUD from substantial losses versus currencies other than the US dollar.
With the exception of the Swiss franc, the performance of the AUD versus all other major currencies throughout 2022 was either flat or positive. The AUD gained 10% ytd in the JPY cross (AUD/JPY) and 3% against the pound (GBP/AUD). The performance versus the New Zealand dollar (AUD/NZD), the euro (EUR/AUD), and the Canadian dollar (AUD/CAD) year to date was unchanged.
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Australia's economic outlook: RBA on a dovish path?
Australia interest rates are still well below the level of inflation – Photo: Capital.com, Source: TradingviewAt its meeting in December 2022, the RBA increased the cash rate by 25 basis points to 3.1%, in line with market expectations. Concerning forward guidance, the committee reaffirmed that the policy rate was not on a predetermined path, as the magnitude and timing of future rate hikes will continue to be determined by incoming data.
Inflation is excessive historically and well above RBA interest rates. In the latest monthly Consumer Price Index (CPI) reading, inflation slowed to 6.9% in the year to October 2022, down from September's record high of 7.3% and missing market consensus of 7.4%.
Meanwhile, the economy is indicating the first signs of weakening, as rising inflation and increasing interest rates weighed on household incomes. In November 2022, the S&P Global Australia Composite PMI dropped to 48, signalling the biggest loss in private sector activity since January. While manufacturing growth slowed (51.3), the services sector was the biggest drag, dropping at the steepest pace since January (47.6).
After increasing by 0.6% in September, retail sales in Australia dropped by 0.2% year-over-year in October 2022, the first annual decline in retail trade thus far in 2022.
In its most recent World Economic Outlook released in October 2022, the IMF forecast that the Australian economy will expand by 1.9% in 2023, down from 3.8% in 2022. According to the Fund, inflation will average 4.8% next year, down from 6.5% in 2022.
Therefore, recent economic headlines show a decline in Australian economic activity, which, if it leads to a reduction in inflation, might convince the RBA to halt interest rate rises in 2023. This represents a negative factor for the Australian dollar, all else being equal.
RBA interest rates: What is the market pricing in?
The market is pricing in a relatively dovish rate hike cycle by the RBA in 2023, taking into account the latest macro developments and Governor Lowe's forward guidance.
Investors expect the RBA to raise the cash rate by a cumulative 50 basis points in the first half of 2023, bringing it to roughly 5.55-5.6% by July 2023.
The market is split between a 25-year hike and a hold for the February 2023 RBA meeting, with the former marginally more likely.
However, the RBA's rate hike cycle will decelerate far quicker than the Federal Reserve's in the first half of 2023, since the market still anticipates a 125-basis-point increase in fed funds through May 2023.
Interest rate differentials between the United States and Australia may widen further in the first half of 2023 before narrowing in the second half of the year, when the Fed is projected to pivot.
| RBA meeting | Rate priced | Increase priced (bps) | Sum of increases priced (bps) |
|---|---|---|---|
| 07-Feb-23 | 3.22% | 16 | 16 |
| 07-Mar-23 | 3.31% | 9 | 25 |
| 04-Apr-23 | 3.35% | 5 | 30 |
| 02-May-23 | 3.42% | 7 | 37 |
| 06-Jun-23 | 3.49% | 7 | 44 |
| 04-Jul-23 | 3.56% | 6 | 50 |
Data as of December 6th, 2022
Bullish catalyst for the AUD: China's reopening
One of the key themes for the Australian dollar in 2023 will be on the reopening of the Chinese economy after the Covid lockdowns that dominated 2022.
China is the AUD's biggest export partner, accounting for 40% of Australian exports, making the Australian economy particularly sensitive to Chinese demand growth for global commodities.
The link between the Aussie and Chinese assets has become considerably stronger in recent months, and I expect it will continue to be the AUD's playbook in 2023, as the Federal Reserve approaches the end of its tightening cycle and investor focus shifts to global growth.
The Australian dollar has a very strong and positive correlation with the Chinese yuan (USD/CNH) (0.89), as well as a significant oisutuve correlation with the Chinese A50 stock market index (CN50) and iron ore prices. The commodity contributes for up to 25% of Australian exports, and China imports the majority of it (70% of worldwide iron ore).
Rising expectations of a Chinese economic reopening might fuel a cyclical AUD surge next year, allowing the Australian dollar to outperform peers owing to its stronger ties to China.
The potential for the AUD to rise increases with how much policy stimulus, such as fiscal or monetary policy easing by Chinese policymakers, is deployed to support the Chinese economy.
However, the Federal Reserve is always a major source of downside risk for the Australian dollar, since higher-than-expected Fed hikes may impact on interest rate differentials between the US and Australia, and thus weigh AUD/USD pair.
Bearish catalyst for the AUD: RBA-Fed rate differentials
AUD/USD vs 2-year Australian-US government bond yields – Photo: Capital.com, Source: TradingviewOne of the main causes influencing the AUD/USD negative trend in 2022 has also been the narrowing short-term interest rate spreads between the 2-year Australian and US government bond yields.
AU-US 2-year government bond yield differentials have essentially mirrored the divergent market outlooks for upcoming rate hikes between the RBA and the Fed.
The narrower the rate differential, the higher market expected the Fed to outperform the RBA in terms of hikes, thereby putting pressure on the AUD/USD exchange rate.
Between June and November 2022, the Federal Reserve strongly accelerated rate hikes, delivering four consecutive 75bps hikes, leading the AU-US 2-year spread to plunge from a peak of 0.3% in mid-June to a low of -1.4% at the beginning of November.
In November, the relationship between AUD/USD and short-term yield differentials began to break, as the Australian dollar appreciated but the yield gap scarcely changed. However, the AUD/USD is presently trading at a premium to the short-term rate spread, signalling that other factors, like China, may have contributed to the Aussie's latest positive reaction.
Short-term rate differentials may still have an impact on the Australian dollar in 2023, but not as much as they did in 2022, as the Fed nears the end of its cycle and the Chinese reopening approaches. However, if predictions of a dovish RBA and a still-hawkish Fed materialise in the first quarter of 2023, the rate-differential factor may remain a downside risk for the AUD.
Commitments of traders (COT): Speculators retain net short Aussie bets
AUD/USD vs AUD CFTC commitments of traders from non-commercial traders – Photo: Capital.com, Source: TradingviewMarket attitude toward the AUD remains bearish, but to a lower level than at the start of 2022. According to the Commodity Futures Trading Commission's (CFTC) weekly Commitments of Traders (COT) report for the 2nd of December, net speculative positions on the Australian dollar currency were equal to -44.6K contracts, rising marginally from the previous week (-42.8K).
AUD speculative net shorts ranged from -60K to -27K between March and December 2022. Overall, as of December 2022, large speculators have significantly reduced their net short position in the Australian dollar from -91K contracts at the beginning of January 2022.
If the reduction of the speculative net short positions in the Aussie dollar continues next year, we can see the AUD/USD benefiting from that. However, the correlation between COT speculative positioning and AUD/USD price action has been weak thus far in 2022.
AUD/USD technical analysis: 2022 channel breached, but not yet a bull market
AUD/USD daily chart and technical analysis as of December 7, 2022 – Photo: Capital.com, Source: TradingviewAfter a 19.4% decline between the April 2022 highs of 0.7661 and the October 13 lows of 0.617, the Australian dollar strongly rebounded by nearly 10% to 0.672 on December 7, 2022, climbing above its 50-day moving average and exiting the 2022 bearish channel.
The AUD/USD daily chart shows significant support and resistance levels in the near future.
The recent price action is testing the 38.2% Fibonacci retracement level from the lows of 2022 to the highs. However, we might see profit taking and renewed negative pressure if prices approach 0.69, which coincides with the 200-day moving average and the crucial 50% Fibonacci retracement line.
If the AUD/USD pair is able to convincingly break over that barrier and then its highs from August at 0.713, it might clear the path for an extension into 0.734 (the 78.6% Fibonacci level) or above to 0.766 (April 2022 highs). This strong bull scenario for the Aussie may play out further in the second quarter or second half of the year if the Fed pivots and China reopens.
On the downside, there is an attractive support zone between 0.651-0.652, which includes the 50-day moving average as well as the 23.6% Fibonacci level. If AUD/USD finds support there, the region might become a significant confluence zone, as it was a very powerful technical resistance from September 26 and November 9.
A retest of the 0.637-0.617 range, where Aussie traded between October 10 and October 21 and twice entered oversold territory, seems less likely in the very short term, given that those levels marked extreme Fed rate hike worries and no reopening expectations in China.
Overall, I think the AUD/USD pair could manage to fluctuate in a tight range between 0.65 and 0.70 in the first quarter of next year, with the latter being tested and possibly broken after the end of Q1. The likelihood of a bullish trend in the Aussie increases the faster China reopens from Covid and the more the Fed indicates the end of its rising cycle.
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