Australian dollar trade balance topped, pointing to ‘just’ lower valuations

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– The AUD’s biggest safety net is its trade surplus
– It remains close to the records
– But all the signs point to it falling from here
– Driven by the bursting of the iron ore price bubble
– The fair value of the AUD will fall accordingly

Photo © Adobe Stock

The outlook for the Australian dollar will largely depend on whether the country continues to print favorable trade momentum, therefore, what happens to oil, iron and natural gas prices in the future will matter. .

Australia’s export strength has been a lasting source of support for its currency: despite Covid lockdowns and a still dovish central bank, the Aussie dollar can build on its strong trade momentum.

Australia released another set of strong trade figures on November 04, but there are signs that the trade balance peak could now be reached and this will likely drive down the ‘fair value’ of the Australian dollar.

The September trade balance stood at A$12.243 billion says ABS, which is higher than the 12.20 billion Australian dollars expected by the markets, but down from August’s record of 15.077 billion Australian dollars.

“Despite the sharp decline, this is still an extremely large surplus and is the third highest on record,” says Adelaide Timbrell, senior economist at ANZ.

Export earnings fell sharply, down 6.4% (-A$3.1bn), but lower imports (-1.8% / -$0.6bn) dampened the overall downward impact on the trade surplus.


Trade surplus

Above: “Trade surplus: down from August peak” – Westpac.

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As expected, coal and natural gas exports supported the strong export reading, but oil and coal prices have now reached their highs since September and concerns continue to grow over the outlook for ore export earnings railway from Australia.

The outlook for the Australian dollar will largely depend on whether the country continues to print favorable trade momentum, therefore, what happens to oil, iron and natural gas prices in the future will matter. .

The chart below from Westpac shows how the AUD/USD fair value has changed over the past few years and how the exchange rate follows:


Fair value of the Australian dollar


As can be seen above, the Aussie’s fair value is currently above the spot, suggesting room for upside.

But if this fair value were to fall, the upside margin would necessarily be reduced.

Frenzied demand for coal and natural gas – Australia’s second and third largest exports – has come to an end, which is reflected in Newcastle’s benchmark Australian coal price.

This coal contract fell back from an Oct 06 peak at $267/tonne to $152/tonne as strong demand in China and India eases as supply rises again after the recent shock:


Coal prices in Newcastle

Above: The price variation of the Newcastle coal contract in Australia for delivery in December.

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Australia’s top export, iron ore, meanwhile fell into a downtrend amid weaker steel output and an economic slowdown in China.

The price of iron recently fell back below $100 a ton after falling more than 20% over the past week according to Fastmarkets MB.

“The peak of the trade surplus has passed, now that the iron ore price bubble has burst,” said Andrew Hanlan, senior economist at Westpac.


Exports of metal ores

Above: “Metal Ore Exports and Iron Ore Prices” – Westpac.


The main destination for Australian iron ore remains China where an economic downturn could well drag on over the next few weeks as authorities impose new Covid lockdowns and seek to reduce pollution levels ahead of the Winter Olympics.

Economic growth in the world’s second largest economy continues to slow in the middle of reports Chinese authorities are shielding Beijing from the growing Covid-19 outbreaks that have now permeated more than half of the country’s provinces, seeking to protect the capital as it prepares to host top political leaders next week and the Olympics in winter in less than 100 days.

The increase in Covid cases is accompanied by a slowdown in the real estate market, illustrated by The Evergrande Group fiasco.

The authorities are aware that Evergrande – a mega developer – is symptomatic of the imbalances in the real estate sector and are acting to curb the excesses, this will involve slowing the supply of new developments to the market by overstretched developers.

Chinese real estate developments fell 13.5% year-on-year in September alone and cement production fell 13% and steel production 14.8%, according to SP Angel analyst John Meyer.

Demand for steel for construction projects has sucked Australia’s iron ore in recent years, but now it looks like the peak has been reached for the sector.


Metal ore export earnings

Above: “Export revenue: metal ores fall” – Westpac.


ANZ economists say they expect Australia’s trade balance to peak in 2021 as falling commodity prices are expected to reduce the surplus over the next year.

Additionally, with the easing of nationwide lockdowns, ANZ economists expect consumer imports to rise over the coming months, which will boost imports.

If Australia’s terms of trade were to moderate, the fair value level of the Australian dollar would stop rising and could start falling.

This leaves the currency exposed to further dovishness from the RBA, which remains resolute in its desire to keep interest rates unchanged until 2022.

But, the easing of the Covid crisis in Australia and the recovery of domestic consumption should offer some compensation for a retracement of export earnings.

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