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What Does Omicron Mean for the Aussie?

The emergence of the Omicron variant of Covid-19 rattled markets late last week, knocking the Aussie to 3 month lows. Australia’s busy calendar this week includes Q3 GDP but the key to AUD/USD’s near-term prospects may be the reaction of Fed officials to the latest twist in the pandemic.

What does Omicron mean for the Aussie?

Last week AUD/USD fell for a fourth straight week, but the decline accelerated on Friday and included a low of 0.7113, barely above the 2021 lows recorded on 20 August. The day between the US Thanksgiving holiday and weekend is typically quiet for financial markets, but the emergence of a new ‘variant of concern’ of Covid-19 changed all that.

Investors might have been forgiven for expecting that Covid-19 would not deliver any more sudden jolts to markets. But the knee-jerk responses by governments such as the UK to block flights from southern Africa and even impose restrictions on flights from elsewhere cast a cloud over the services sector recovery. Shares in tourism-sensitive sectors plunged, as did oil prices, while vaccine manufacturers surged.

Notably for FX markets, US yields dropped steeply too. The 2 year US treasury yield fell from 0.64% pre-Thanksgiving to 0.50% on Friday, though it ticked back up to 0.54% on Monday as US equity futures trimmed losses somewhat. The US dollar lost ground against the euro and Japanese yen.

Westpac Economics revised its outlook on the Federal Reserve just ahead of the Omicron designation by the WHO. Given the surge in US inflation and strong economic growth, Westpac now sees the 14-15 December FOMC meeting resulting in a faster reduction in bond purchases, now wrapping up in March 2022. This would set the stage for rate hikes starting in June 2022.

Such an outlook would be very supportive for the US dollar against the Aussie given Westpac’s view that the RBA keeps its cash rate at 0.1% through 2022. In coming days though, the debate will rage over whether central banks regard Omicron as a game changer for the policy outlook. This adds extra focus on comment from Fed officials this week, especially Chair Powell’s testimony to Congress.

Of course the final US employment report before the pivotal FOMC meeting will also be important for the US dollar’s prospects. We expect the Omicron mood and December non-farm payrolls to be key in whether AUD/USD can stabilise around 0.7050/0.7200 or continue its weekly declines. But there is plenty on the local calendar too.

Australia’s Q3 GDP data will bear the brunt of the Delta-driven lockdowns, especially in Sydney and Melbourne. We look for a contraction around -2.5%, the second-weakest quarter in the past 50 years (Q2 2020 of course being the worst, -7%). We know that recovery is under way, but Q3 GDP will show us how deep a hole the economy was in before reopening. October retail sales offered some encouragement for Q4, up 4.9%mth, but the harsher the response by Australia’s federal and state governments to Omicron, the weaker the summer economic rebound.

Event risk this week

Aust Q3 balance of payments and public demand, Aust Oct dwelling approvals and private credit, RBA’s Debelle speaks, China Nov manufacturing and services PMIs, US Nov consumer confidence, Fed Chair Powell testifies to Senate (Tue), Aust Q3 GDP, US Nov manufacturing ISM (Wed), Aust Oct housing finance and trade balance (Thu), US Nov employment report (Fri)

Westpac Banking Corporation
Westpac Banking Corporationhttps://www.westpac.com.au/
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

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