Australia: Economic facing rough times – Rabobank

In view of Jane Foley, Senior FX Strategist at Rabobank, the overnight news that Australia registered a record trade surplus for March at AUD3.1 bln was a disappointment to the market. 

Key Quotes

“Admittedly the strength of the surpluses this year has been a far cry from the spate of deficits registered between early 2014 and late last year.  However, with the 4% rise in metal ores and minerals being a main component behind the strength of the March data looking unsustainable, there is concern that Australia’s trade position could be about to worsen.”

“Overnight iron prices registered their biggest one day drop so far this year.  Iron ore futures dived 7.7% in Asian trade with copper and other metals also coming under pressure.  Following last year’s surge in iron ore prices, speculation is growing that additional supply will weigh heavily on prices going forward.”

“Despite expectations of an increase in supply of iron ore, there is still optimism regarding demand for steel in the market.  Better levels of world growth are a supportive factor.  A World Steel Association report on preliminary crude steel production shows particularly strong infrastructure investment and automobile related demand in India.  Some of this demand is likely to be quenched by supply from Australia.  That said, the outlook for demand from China, which is Australia’s largest trading partner, carries some uncertainty.”

“Strong growth in China has been supported by sharply rising levels of credit which raise the risk of a hard landing further down the road. Given that China is the biggest consumer of commodities in the world, worries about Chinese growth have clear links with the outlook for prices of outputs such as iron ore and coal which are Australia’s largest export products.  In its policy statement earlier this week, the RBA predicted that while Australia’s terms of trade have recently increased, some reversal of this is already occurring.”

“Softer prices for iron ore if sustained would feed back into Australian households and eventually put downside pressure on inflation.   Although CPI inflation picked up to above 2% in Q1, core inflation remains low in part reflecting the weakness of earnings growth.  Earlier this week the RBA confirmed steady policy as expected and indicated that the RBA is in no rush to alter monetary policy settings either way.  Overnight RBA Governor Lowe warned about the dangers of high levels of household debt which have been fed by low interest rates.  He commented that high household debt levels have made the economy less resilient to shocks and that interest rate will not always be that low.  While that statement appeased the AUD bulls, in its policy statement this week the RBA warned that in reference to the economy’s transition following the mining investment boom, “an appreciating exchange rate would complicate this adjustment”.  We expect AUD/USD to edge towards the 0.72 level by year end with negative news regarding Chinese growth likely to increase downside risk.”