The latest bounce in the iron ore price, which recently bounced close to its June 2015 highs, seems to best capture the improvement in the fundamental backdrop for AUD of late. While the rally has been exaggerated by poor market liquidity conditions, it nevertheless epitomizes how the ongoing rebalancing of the Chinese economy coupled with the continuing official support for the recovery could be positive for the antipodean currency.
For starters, we note that the rebound in the iron ore prices reflects the recovering investors’ optimism in the Chinese outlook in the wake of the NPC over the weekend. In addition, we suspect that the rebound also reflects the latest official efforts to cut excess capacity in the Chinese mining sector, which could see as much as 15% of the labour force there being let go. The oversupply of steel and other industrial inputs has long depressed the prices of iron ore and other Australian exports. With the oversupply now presumably abating but with the Chinese demand still fairly robust thanks to the newly-announced fiscal stimulus measures, iron ore and AUD could remain supported for now.
The longer-term outlook for AUD may be less rosy, however, especially against USD. In particular, we note that further fiscal stimulus and restructuring could mean even weaker growth in China in coming quarters and years. While infrastructure spending and property development may still support domestic investment and hence demand for Australia’s commodity exports, we doubt that prices could revisit their previous highs. This will partly reflect the resilience of USD, which should remain supported broadly as markets continue to re-price the prospect for further Fed tightening from here.
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