2 July 2013

Can Today's Pivotal RBA Decision Rescue the Aussie?

RBA likely to stay on hold with thoughts on external factors rather than domestic.

The overriding consensus is that the Reserve Bank of Australia (RBA) will keep its cash rate at 2.75% at its July policy meeting today at 14:30 AEST. Although a 'no change' decision may support the AUD, the RBA's post-meeting statement will be crucial in swaying an even more speculative brood of traders/investors since the Fed's June 19th FOMC meeting.

It is likely that the central bank will maintain an easing bias, possibly suggesting that a rate cut could come in August if July’s inflation reading is towards the lower end of the RBA’s 2%-3% target range.But there doesn’t seem to be a need to ease this month: inflation looks stable, with CPI coming in at 2.4% for May and June. Australian manufacturing put in a good performance in June, buoyed by low rates and a sliding AUD, especially against USD. At the time of writing futures markets are pricing in a 25% chance of a 25bps cut.

Moody’s also announced yesterday that the outlook for Australia’s Aaa rating remains stable. The ratings agency said “the ratings are based on the country’s very high economic resiliency, very high government financial strength, and very low susceptibility to event risk.” This remains to be seen because as we saw in 2008, sometimes a country can be forced into credit rate downgrades, policy changes and suffer tremendous market turmoil despite being relatively insulated from other, more disturbed nations.

Recent turmoil

The Federal Reserve's chairman Ben Bernanke’s critical policy shift on June 19th has unsettled global markets and has caused rather a lot of confusion. Was the Fed actually serious about slowing and withdrawing stimulus so soon? Considering that the world's stock markets, commodities and bond markets rely on Fed market intervention to maintain their lofty highs? Or maybe the Fed was simply too optimistic leading to market misunderstanding of their true intentions? Time will tell but in the meantime, AUD/USD selling continues spurred by Fed actions and comments. On a trade-weighted basis, the AUD has fallen 11% in the last two months. A boon for Australian exporters but this could also lead to inflationary effects later this year.

As global commodity prices ease off their highs, the AUD/USD has fallen from $1.05 in April to approximately $0.92 (3 year low) at the time of writing. The AUD's depreciation has to some extent, given a helping hand to the RBA, mitigating the need for the central bank to take immediate policy action. We think the AUD is the prime reason why the RBA will continue to remain patient and wait for further market developments. As commodity prices deflate, Australian policymakers should re-focus the economy away from dependency on commodities (and their associated industries) in order to avoid the Australian economy being tied to commodity price volatility - largely due to outside factors which Australia cannot influence. The new Australian Prime Minister, Kevin Rudd underlined this very point last week by saying:

“Australia must continue to diversify its economy, not to have all our eggs in one basket"

Domestically, media focus and political talking points have surrounded the ousting of former Prime Minister Julia Gillard by Kevin Rudd. However, this changing of the guard is unlikely to feature too heavily in the RBA’s thinking. Political games do not affect economic factors unless there are expectations of a clear policy divergence between the two parties. For the time being, investors cannot see enough clear daylight between Rudd and Abbott for asset prices to be affected.

Chinese influence

The RBA will, however, be keeping an eye on developments in China; weaker Chinese manufacturing PMI data pushed AUD/USD down to $0.9110 on Monday morning as a clear indication that speculative FX flows are keenly sensitive to market events in China - Australia's largest trading partner. Goldman Sachs recently revised its 2013 Chinese growth estimate to 7.4%, while Credit Suisse are forecasting growth of 6% in 2013, despite official Chinese forecasts expecting 7.5% growth in 2013. Slowing Chinese commodity tends to weigh on the Australian economy and AUD so further evidence of slowing (or just expectations/estimates showing thus) in the world’s second largest economy is likely to be AUD negative. Additionally, there is the prospect of a Chinese liquidity shortage as a throwback to Lehmann Brothers in 2008.

Short-term funding, overleveraging, toxic debt and a housing bubble are all words the Western world has heard before and soon it could be China's turn to clean up its banking sector via record government bailouts and asset purchases. If Western policymakers are assumed to be honest in their reporting of official macro data, China's reputation is not so clean. We could hear allegations of false reporting and even more worryingly, we could see an admission of misreporting by PBOC/government officials - this could prompt Western investors to cascade away from Asian markets just like what happened after Greece admitted misrepresenting official accounting figures in 2009.

AUD/USD Outlook

Given all of the attention on the U.S. Fed, any major moves in the AUD/USD currency pair are likely to be USD driven and highly speculative. In the short-medium term, there is a high likelihood of further AUD downside, as the Fed moves towards tighter monetary policy and the RBA maintains a dovish bias. AUD/USD is currently trading (0.9222) much closer to the high of its record range (1.10) than its low (0.47) so investors may be inclined to take short positions considering the long-term average. Fibonacci levels suggest that AUD/USD support is currently around the $0.9140 level; and resistance in the $0.9450 region.

AUD/USD Bearish Risks:

Downside follow-through on further dovish statements from the RBA while the US dollar remains bullish against other G10 currencies, adding to spec long USD positions against AUD

AUD/USD Bullish Risks:

A more hawkish tone would allow for a rebound, and set up a correction towards the 0.9440/50 area - likely to incur strong resistance here and cap gains.

Commissioned by Think Forex