Australian Dollar Outlook: AUD/USD Downside Risks as the US Dollar Soars

The Australian Dollar broke lower during a week where the US Dollar broadly strengthened. The Delta variant continued spreading as Chinese crackdowns weighed against several local stock market sectors. The strengthening US Dollar pushed commodity prices lower. Iron ore prices have moved sharply lower and the outlook remains negative. China stated that steel production for the rest of the year must be reduced.

This comes at a time of year when Brazil typically ramps up output. A fundamental concern is the cost of shipping. This past week, China closed several major ports due to Delta and this pushed the Baltic dry freight index to 10 year highs. Iron ore is a crucial component of Australias economy. A US$10 move in the iron ore price has a circa AUD 2 billion impact on Australian government revenue. The market will focus on key developments related to the commodity as the direction of the Australian Dollar is closely linked to iron ore prices.

AUD/USD, IRON ORE AND SHIPPING COSTS OF IRON ORE (BALTIC FREIGHT DRY INDEX)

AUSTRALIAN DOLLAR, RISK ASSETS AND THE FED

Recent weakness in global stock markets is likely adding additional downside risk to the Australian Dollar, which can at times also be sensitive to swings in trader sentiment.. This synchronicity appears to be growing as we have seen USD strengthen against most commodities and all currencies, except CHF and JPY, which remained comparably flat this week. If the latter two currencies start being bought aggressively, this could reflect a large risk off event and would likely be associated with more downward pressure on the growth-linked Australian Dollar.

The lead up to the Jackson Hole Symposium on Thursday is likely to see some Fed speakers prepare markets for the event with preliminary speeches. The FOMC minutes revealed the possibility of tapering but circumstances have changed since that meeting and the market will be highly attuned for any clues for action.

In Australia we have building approvals, business capex and retail sales data starting on Wednesday. The market will likely focus mostly on retail sales for an indication of how the consumer is reacting to lockdowns.