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AUD: What to Expect from the RBA

Last updated 10/3/2011 1:07 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

The Reserve Bank of Australia has a monetary policy announcement this evening and the wide divergence between what investors and economists expect points to a potentially volatile reaction in the Australian dollar. Economists expect the central bank to leave interest rates unchanged at 4.75 percent but for the past few months, investors have been pricing in a 75 to 100bp rate cut by the RBA before the end of the year. For this meeting in particular, no one believes the RBA will lower interest rates but if the central bank were to cut in November like investors expect, they would need to move from a “wait and see mode” into a “we are gearing up to cut rates mode.” The problem is that even though the market has been discounting a series of rate cuts by the RBA before year’s end, the central bank has refused to acknowledge the need for stimulus. If they continue to ignore the calls for easing, A$ traders may have no choice but to cut their short positions. 

Australian Economy – Some Weakness, Some Strength

Recent economic data gives the Reserve Bank very little cause for optimism. Australia experienced net job losses in July and August, causing the unemployment rate to rise to 5.3 percent, the highest level since October 2010. The retail sales report is not scheduled for release until after the central bank meeting but the deterioration in the labor market should have negatively affected demand.  Commodity and equity prices have fallen since the last meeting along with bond yields. Although there have been improvements in leading indicators, the trade balance and service sector activity, these reports are from July which makes them dated. However the improvements in business and consumer confidence could make the central bank forgo a rate cut in November because optimism could fuel spending. Most importantly, Australia’s economy is intimately tied to China’s and the recent improvements in manufacturing and service sector activity could keep the central bank firmly on hold for another month. 

When the RBA last met in September, monetary policy officials felt that they were well equipped to handle slower global and domestic growth or an increase in inflation. They emphasized the continuation in the mining investment boom and high terms of trade.  More recently, RBA officials downplayed the significance of the U.S. economy on domestic growth and spoke of the increasing importance of China, which is clearly their attempt to tell investors that for the time being, demand from China continues to shelter them from the global economic troubles. With little consistency in economic data, the only major changes since September for the RBA to consider are the increased volatility in the financial markets, the recent downgrades across the globe and the sharp slide in the Australian dollar. In early September, the AUD/USD was trading around 1.05/1.06 and on the eve of the RBA meeting, the currency pair is 8 to 9 percent weaker. In some ways, it can be argued that the weaker currency gives the RBA more flexibility to lower rates, but at the same time, it is also more stimulative for Australia’s economy, reducing the need for a rate cut.   This lack of clarity is the main reason why we believe the RBA will remain firmly neutral, which could trigger a relief rally in the AUD/USD. 

The following chart shows how sharp of a decline the Australian dollar has seen over the past month. If the RBA decides the risks to the global economy warrants increased concern and possibly even a rate cut, the AUD/USD could fall to 95 cents, which would be a one year low. If they remain neutral like we expect, a relief rally could drive the AUD/USD back to 98 cents. 

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.