Australian dollar forecast: will China PMI help reverse AUD/USD’s decline?

AUD/USD forecast - neutral

The slide in the Australian dollar has paused following surprisingly strong China manufacturing and services data. However, for AUD/USD’s rebound to be sustainable, Australia’s growth and monetary policy divergence with US may need to reverse.

Australia macro data since the beginning of March have been underwhelming.

The Australian economy grew at the weakest pace in a year last quarter while monthly consumer prices rose less than expected in January. Building approvals fell the most on record suggesting that the housing market is feeling the heat of the Reserve Bank of Australia’s rate hikes. Rate futures are nearly unchanged, now pricing in the terminal cash rate at 4.18%, around 4.17% two weeks ago.

Given that household leverage has risen significantly over the past two decades, the rate hikes could have adverse repercussions on household balance sheets. Key focus is now on RBA interest rate decision due Tuesday, March 7 – the central bank is widely expected to hike the cash rate by 25 basis points.

AUD/USD vs Australia Economic Surprise Index (ESI) relative to US ESI

In contrast, US macro data have beaten expectations since the start of February. US rate futures are now pricing in Fed rate at 5.43%, up from 5.25% two weeks ago.

The relative underperformance of the Australian economy and AUD/USD recently is reflected in the Economic Surprise Indices (ESI) - the Australian ESI is languishing around the 2020 lows, while its US counterpart is at the highest level in 10 months (See chart).

Australia household finances vs housing prices

For now, though, stronger-than-expected China manufacturing and services activity data on Wednesday appears to have provided a floor to AUD/USD. The data reminded investors that the reopening story is alive that bodes well not only for the world’s second largest economy’s growth outlook.

China accounts for about half of the industrial metal demand and about two-thirds of the world’s iron ore. China is Australia’s biggest export market and iron is Australia’s largest export earner.

AUD/USD daily chart

On technical charts, AUD/USD’s slide has paused following China manufacturing data beat ahead of the support-turned-resistance on the 200-day moving average, slightly above the November low of 0.6585. So far, the recent retreat seems to be a correction within the broader uptrend. However, any break below the pair would pose a risk to the four-month-long uptrend.

On the upside, AUD/USD would need to clear a tough ceiling at 0.6785-0.6800 (including Wednesday’s low of 0.6785 and the mid-February low of 0.6800) for the immediate downward pressure to fade.

AUD/USD 240-minute Chart