Summary:

• UBS doesn’t see a negative impact on the AUD from iron ore at this stage
• Bank’s view could change if prices of commodity deepen their declines
• Technical analysis seems to offer further space for bulls

There is no doubt that the main driver of the rally seen in the AUDUSD at the beginning of this year was a stunning rebound in iron ore prices. Prices of a key commodity for the Australian economy soared from ca. $55 to almost $95 over the course of five months. A peak was achieved in February, since then there’s been a downward trend in prices. 

Really interesting point of view has been expressed by UBS analysts who call into question a negative impact on the AUD stemming from declines in iron ore prices. According to them, while market woes over a slowdown in China growth appear to have receded somewhat over the past month, iron ore remains fairly depressed at around $56 per tonne comparing to $86 seen in Q1 2017. Either way, deeper decreases in iron ore prices could be worrisome. 

UBS’s commodity analysts expect iron ore prices to average $71/t in 2017 – which should facilitate a record-high trade surplus, over time supporting AUD – and end the year at $60/t. On the other hand, bank’s FX analysts estimate that their year-end AUD/USD forecast from a flow perspective is consistent with an average 2017 iron ore price of $65/t, which would be realized at steady spot prices around current levels until year-end. 

Moreover, they think that inflation in Australia has likely bottomed out and there are signs that wages are due to pick up as well. The banks underlines that a sustained turnaround in wages is a likely precondition ahead of any hawkish shift from the RBA. 

All in all, the bank is modestly bullish regarding the AUD based on its beta to global growth, and its view that the RBA is done easing. Besides, UBS expects that commodity-related FX inflows to provide support for the AUD. At the end of the day, it’s worth mentioning that in previous episodes of trade surpluses saw commodity prices trump rate differentials as a driver of the FX. 

Australian trade balance has showed surpluses over the course of the past five months but without higher iron ore prices it could struggle to become in the positive territory. Source: Bloomberg

In turn, looking at a correlation between iron ore and the AUDUSD in the long-term there is no space to continue rally on the pair. Hence, one could assume the AUD might struggle to keep on rising without a more-sustained rebound in iron ore prices.

Iron ore prices point to slight overvaluation of the Australian dollar in the long-term. Source: Bloomberg, XTB Research

Taking a look at price action one could assume the uptrend to continue as the pair has rebounded from the local support area. The first more important goal which bulls could aim for it’s placed at around 0.7750. For that reason, bulls appear to have quite substantial room to gain.

The AUDUSD could keep on creeping up as the pair has managed to remain above the local support zone. Source: xStation