Nomura FX Insights: AUD: Seasonality or coincidence?

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Nomura FX Insights AUD

AUD/USD has fallen repeatedly in May over the past few years. Some participants are quick to suggest “seasonality”, but a deeper analysis illustrates there has been a run of macroeconomic developments that have driven the moves. This has included a narrowing of the Australia-US two-year swap spread, sharp falls in commodity prices and a stronger USD on either geopolitical or US Fed-related factors. We do not expect this to occur in 2017. We look for AUD/USD to consolidate, but for AUD to underperform other key crosses, such as EUR/AUD.

AUD seasonality?

Looking back, there has been a tendency for AUD/USD to fall in the month of May. Between 1995 and 2016, AUD depreciated against USD 16 out of the 22 years, by an average of 1.3%. Recently, these falls have been more pronounced, with an average fall of close to 5% between 2010 and 2016. At face value, this points to seasonality in the AUD, but a deeper analysis into the factors behind the moves points more to coincidence.

Some participants have in the past been quick to extrapolate that a “sell in May” phenomenon and perceived seasonality across other asset markets as factors that have weighed on the AUD. But we think this is a quick and easy conclusion. Indeed, despite the market fixation with the notion, it is worth highlighting that the benchmark US S&P 500 equity market has actually risen in May more times than it has fallen since 1995 (14 increases compared with eight falls), with declines tending to come through in following months.

In terms of AUD, statistical analysis finds no stable seasonality in May (or any other months). We would also add that if there were a seasonal bias, this should have presumably led to broad-based AUD weakness in May, rather than being concentrated against USD and CAD (Figure 1).

Fig. 1: AUD Monthly Bias’

Figure-1

Source: Bloomberg, Nomura FX Insights

Play the ball not the man

In our view, the prevailing macroeconomic backdrop at the time is the main consideration, not supposed seasonality, which has been behind the run of falls in AUD in May.
With respect to some of the key AUD/USD drivers we would point out that:

(a) The USD index has risen in May in recent years. As we pointed out previously, there have been a series of macroeconomic and/or geopolitical reasons behind the stronger USD / weaker EUR in May since 2010. The list includes the eurozone/Greek crisis of 2010, stronger US data and a lack of a rate hike signal by former ECB President Trichet in 2011, weak economy data and another iteration of the Greek crisis and a focus on Spain in 2012, former Fed Chairman Bernanke’s asset purchase taper discussions and weak global data in 2013, ECB President Draghi’s policy easing signals in 2014, the ECB’s Coeuré announcing a front-loading of QE in 2015, and rising US Fed rate-hiking expectations in 2016 (see Nomura FX Insights – The “sell in May” phenomenon, 6 May 2016).

(b) The Australia-US two-year swap spread has, on average, narrowed. Between 1997 and 2016, the average narrowing in the spread was 12bp, but in some years the spread narrowed by as much as 85bp (Figure 2). On the Australian side, since 1997 May has been the month with the highest number of Reserve Bank of Australia (RBA) policy moves (nine in total) (Figure 3). The RBA cut interest rates in May 1997, 2012, 2013, 2015 and 2016. This was in contrast with more hawkish Fed perceptions running through the market in 2013 and 2016. And rate hikes by the RBA in 2000, 2006 and 2010 were offset by Fed hikes (2000 and 2006) and the eruption of the Greek crisis and deterioration in broader risk sentiment in 2010. The US Fed also raised interest rates in May 2005, and was on the cusp of starting its elongated Greenspan-era tightening cycle in May 2004.

(c) Base metal and bulk commodity prices have had a bias to weaken in May, with the LMEX index declining 10 times in the 17 years to 2016. Through the years, the mix of Fed policy tightening or hawkishness, negative risk sentiment, a firmer USD and a run of weaker global data have dampened sentiment in commodities. In terms of Australian-specific commodity prices, iron ore prices have historically declined relatively sharply in May. On average, iron ore prices have fallen by nearly 14% over the past seven Mays, with prices only rising once (in 2015). There are some seasonal elements in this particular commodity, with Chinese domestic supply normally coming on line in the warmer months (i.e. May to September).

Figure-2-3

Source: Bloomberg, RBA, Nomura FX Insights

A repeat in 2017 does not look likely

Rather than simply being beguiled by patterns of the past, the key question for us is whether coincidental macroeconomic events that have transpired to weaken AUD/USD significantly in May will come through again in 2017? In short, we do not think this will be the case.
With respect to the list of AUD drivers highlighted above, we note that:

(a) The RBA kept interest rates on hold at its 2 May meeting and provided no policy bias. On the US side, the FOMC is expected to stand pat at its 3 May policy meeting, but according to our US economists, weaker core PCE inflation, combined with soft Q1 US GDP, and the below-trend March nonfarm payrolls report, poses a challenge for the FOMC in terms of how to assess the overall health of the economy. With the market now pricing in a better-than-50% likelihood of a June FOMC interest rate hike there does look to be scope for expectations to be pared back, particularly if coming US data underwhelm expectations and/or the data-dependent FOMC softens its language. We are looking for the next FOMC rate hike to come through in September. This combination suggests a sharp narrowing in the nominal Australian-US two-year swap spread in May 2017 is not on the table.

(b) In contrast to the recent US data flow, the pulse of the eurozone economy has been strengthening. This, and the broadening market outlook for the ECB to signal a tapering of its asset purchases later this year, should keep the EUR supported, especially if the second round of the French Presidential election (7 May) results in a benign market outcome.

(c) Given the sharp moves lower in iron ore prices over recent weeks, a further large correction in May could be difficult to come by. Nevertheless, the demand and supply imbalance in this market should keep prices at lower absolute levels compared with earlier this year.

All up, barring a sharp deterioration in global risk sentiment, significant outperformance in US economic data, and with broader global growth momentum still positive, we believe this points to AUD/USD consolidating with a potential bounce back towards the top half of the 0.7440-0.7750 range it has occupied since early February over coming weeks, rather than weakening steeply in May as it has in past years (Figure 5). This fits in with our longer-term outlook, where our base case is for AUD/USD to track in and around 0.76 over coming quarters, but for AUD to underperform other key crosses, such as EUR/AUD (see Nomura FX Insights – G10 FX Forecast update, 6 March 2017). The combination of the patchiness in Australian economic data, the lower level of Australia-centric commodity prices, an expected moderation in the Chinese property market and a lack of a positive monetary policy impulse as the RBA remains on the sidelines is in contrast with our upbeat view on the eurozone economy and expectations for the ECB to signal an intention to taper its asset purchases later this year.

Figure-4-5

Source: Nomura FX Insights, Bloomberg

 

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