Q1 2024 AUD/USD Outlook

AUD/USD could benefit from a narrower Fed-RBA rate spread

The Federal Reserve began their tightening cycle two months ahead of the RBA’s, maintained a higher yield throughout their tightening cycle and reached a higher peak of 5.5% compared to the RBA’s 4.35%. The relatively laidback approach from the RBA weighed on AUD/USD due to the negative yield differential, and large speculators reached a record level of net-short exposure to AUD/USD futures.

However, there is a possibility for the RBA-Fed cash rate spread to narrow and support AUD/USD in 2024. The Fed has just announced a significant policy reversal by hinting that their benchmark interest rate could be lowered to 4.6% by the end of 2024. Meanwhile, the RBA is expected to maintain a hawkish stance at its upcoming meetings and keep its rates at 4.35%. With the Fed at a higher rate, they have the potential to cut more quickly than the RBA, narrowing the RBA-Fed spread and lifting AUD/USD.

The RBA next meet on the 6th February, and it will also include their quarterly statement on monetary policy with updated forecasts, their usual statement and their newly added press conference. Given quarterly inflation data would have been released the week prior, this will be an important first meeting and could shape expectations for the following meetings.

_{Source: Refinitiv Eikon}

Will policy lags finally catch up with consumers?

We head into the new year with slightly mixed data, none if which is pointing towards an imminent hard landing for Australia. At least for now. Employment remains firm by historical standards which is a key reason as to why the RBA are likely to retain a hawkish bias at least through Q1. Spending has softened but not at a rate that screams a recession. And if my own experience in Australia is anything to go by, a classic economic recession doesn’t seem imminent with shops and restaurants full and tradies still very much in demand. House prices continue to rise as mortgage demand absorbs higher rates.

But this is now, and policy lags might finally show up in the data as savings become depleted, spending slows and inflation slows further. And that could result in a cut or two by the RBA in the second half of 2024 for a cash rate back in the 3’s.

China’s growth could continue to sag

A strong Australian economy could traditionally be assumed with a bullish outlook on China. However, with China's weak PMI figures, signs of deflation, and a lack of appetite for the government to implement large-scale economic stimulus measures, it is becoming challenging to envision strong growth for Australia in the coming year. Moreover, China is also becoming less reliant on exports as it transitions towards domestically driven growth, which means that Australia's export-driven growth is likely to remain subdued.

Mixed signals from Dr copper

Copper is sending mixed signals about the global economy, and shares a positive correlation with the Australian dollar. Copper’s forward curve is in contango (future prices trade at a premium to spot) and the futures curve is higher than it was one month ago. At a basic level this suggests traders expect copper prices to be higher in the future. Copper also posts positive average returns in Q1 according to its 40-year seasonality.

_{Source: Refinitiv Eikon}

However, futures traders appear to be less convinced of a sustainable rally for copper prices. Although managed funds have switched to net-long exposure and large speculators are on the verge of doing so themselves, this is due to shorts being closed and not longs being initiated.

If China continues to deliver underwhelming data like we have seen so far this year, it will be difficult to justify a sustained rally in copper prices without a supply shock occurring. Additionally, note that copper futures failed to break above the January high while AUD/USD reversed around trend resistance as the markets can rise and fall in tandem.

AUD/USD seasonality is mixed in Q1 and Q2

AUD/USD has risen in Q4 for the fifth year in a row, in line with its seasonal tendency to post positive average returns on October, November and December. Yet the pattern in Q1 is less defined, with a marginally positive expectancy in January and March yet negative average returns in Fed yet with a win-rate of 62.5%.

I have used data from 1983 as this is the year the Australian dollar was freely floated, which also provides 40 years of data for the analysis. If the pattern holds true in 2024, we could be in for choppy returns in Q1 and a rally in April before the adage 'sell in May and go away' takes effect. Q3 tends to generate negative returns ahead of a positive Q4. Please not that past performance is not indicative of future results.

_{Source: Refinitiv Eikon, StoneX}

The prominent months of the year that stand out are:

• April: Strongest average returns with a win rate of 5%
• May: Second weakest returns with a lose rate of 5%
• August: Weakest average returns with a lose rate of 60%
• October and November: Positive average returns with a win rate of 60% and 55% respectively

Potential triggers of volatility for AUD/USD in 2024:

With a high-low range of just under 900 pips, 2023 has been the least volatile year since 2019, and the annual range is also well below the 10-year average of 1230 pips.

On the one hand, this could be an indication of a more volatile year for 2024, as 2019's 600-pip range was followed by a year in excess of 2200 pips. However, that volatility was driven by the COVID-19 pandemic, and unless a similarly significant catalyst emerges, we may find volatility on the lower side again next year.

Hard Landing: If the RBA's tightening cycle leads to a sharp economic slowdown or even a recession, the AUD/USD could fall sharply. This could be triggered by a weaker-than-expected economic performance, a deeper-than-expected housing market correction, or a more pronounced decline in commodity prices.

Growth Outperforms Expectations, Inflation Remains Elevated: A scenario where Australia experiences stronger-than-expected economic growth and inflation remains stubbornly high could boost the AUD/USD. This could occur if the RBA manages to engineer a soft landing and avoid a hard landing, or if the global economy experiences a stronger-than-expected recovery.

AUD/USD futures positioning: Room for more short covering, but where are the bulls?

Large speculators reached a record level of net-short exposure to Australian dollar futures in late September and continued short-covering has allowed AUD/USD to rise against its bearish trend. However, like copper, bulls remain mostly side-lined as they doubt the RBA will hike further. This still leaves room for further upside should bears continue to cover, but until we see bulls’ step back to the table with conviction then upside targets need to remain realistic.

_{Source: Refinitiv Eikon}

AUD/USD technical analysis (weekly chart):

The Australian dollar spent most of 2023 in a downtrend, having fallen over 12% from the February high to October low. In fact, it has effectively been on a downward path over the past three years, which means while it's a well-established trend, it's not a ground-breaking idea to short this market.

What if this year’s decline is part of a larger, bullish trend reversal?

A prominent V-bottom formed in 2020 which can often be found a significant turning points. The 2009 weekly and monthly close lows – which are historically significant as the mark the lows of the GFC – acted as support in 2022 and 2023, both of which are higher lows relative to the 2020 V-bottom low. Furthermore, the decline of the past three years has been less efficient than the rally that preceded it.

• 2020 low to 2021 high: +2500 pips in 49 weeks
• 2021 high to 2022 low: -1800 pips in 85 weeks (it took longer in time to travel less than the prior rally)

Written by Matt Simpson, Market Analyst.

Follow David on X: @cLeverEdge