AUD Update 10th of November

Our bias for the Australian dollar is neutral to bearish in the context of lower inflation readings for Q3, increased lending rates from the major banks and low commodity prices. Negative news from China or bearish price action in metals and stocks will put more short-term pressure on the AUD.

AUD Update:

Interest Rate

Official Cash Rate: 2.00%

Last Change: May 6, 2015 (2.25%)

Expected Future Change: ASX Cash Rate Futures pricing a 23% chance of a cut

Next release: December 7

Inflation

Inflation Target: 2-3%

Period: Year ending September 30

CPI: 1.5% Prior: 1.5%

Trimmed Mean CPI: 2.1% Prior: 2.2%

Next Release: January 27

Employment

Period: September

Employment Change: -5,100 Expected: 5,000

Unemployment Rate: 6.2% Expected: 6.3%

Next Release: November 12

Growth

Period: Year ending June 30 2014

GDP: 2.0% Expected: 2.2%

Next Release: December 2

Analysis

The Aussie dollar has seen a reprieve in recent weeks from the massive declines over the past 24 months. From April 2013 to September 2015, the AUD fell over 36 cents against the greenback. This move is almost entirely associated with the decline in commodity prices, as the domestic economic data from Australia has remained relatively stable during 2015. The slowdown in China has caused a reduction in commodities prices and along with it, risk-off sentiment caused equities to crash during August. Both these markets – stocks and commodities – have a strong positive correlation with the AUD, and therefore the currency was pressured by the declines. The AUD has been a neutral currency over the past few weeks causing it to trade fairly mixed against its major counterparts as the market reacts to data effecting other central banks.

The Reserve Bank of Australia kept rates on hold at 2% on November 3 as was expected. The OIS market was pricing in a 44% chance of a rate cut at this meeting, however we felt that was too high of a probability considering the circumstances. The RBA has continued to express that they are content with where rates are at current levels, and in our opinion, there was no new data that was going to change that point of view. In its statement the Bank said that prospects for an improvement in economic conditions had firmed recently leaving it appropriate to keep interest rates unchanged. Committee members also observed that the outlook for inflation may “afford scope for further easing of policy, should that be appropriate to lend support to demand.” The Board will continue to assess the outlook and whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target. The RBA noted that the Australian dollar was adjusting to the significant declines in key commodity prices. Inflation remains within the central banks 2% to 3% target range, but at a little lower level than expected.

On October 28, CPI for the third quarter missed expectations. The headline figure came in at 0.5% for the quarter, below expectation of 0.6%, and 1.5% for the year, below expectation of 1.7%. Although the headline year-over-year reading of 1.5% was unchanged since the end of the second quarter, the major weakness of the release was seen in the Trimmed Mean CPI figures – which are the RBA’s preferred measure of underlying inflation. Trimmed Mean CPI came in at 0.3% for the quarter, below expectations of 0.5%, and at 2.1% for the year, below expectations of 2.4%. Both the Trimmed Mean figures were below the lowest estimate of 16 economists surveyed by Reuters, and the year-over-year number represented a 3-year low. The AUD dropped immediately upon release with Aussie instantly down 70 pips. The miss on the inflation print saw chances of a November rate cut increase.

During early October the ‘big four’ Australian banks – (Commonwealth, Westpac, ANZ and National Australia Bank) – all announced they will increase variable rates on mortgages. This tightening of lending at the retail level has prompted some analysts to predict that the RBA will have to cut rates to compensate and rebalance interest rates for the consumer. With that said, this is not within the scope of the RBA’s mandate, and it is very unlikely that the central bank would be seen reacting to this development. If anything, the RBA would need to first access it’s effects on the real economy moving forward.

Employment figures for September, released October 15, missed estimates slightly and showed the first decrease in employment change in five months. The release showed a reduction of 5,100 jobs against expectations of a 5,000 job gain. The unemployment rate however remained at 6.2%, and this beat expectations. Overall the release was relatively benign and does little to change any fundamental factors for the Australian economy.

Gross domestic product for the second quarter, released on September 1, missed expectations. Increasing less than expected at 0.2% on the quarter, with analysts expecting an increase of 0.4%. Year-over-year, GDP was up 2.0%, also below expectations. Reduced mining and construction activity, coupled with a decline in exports were the main factors in the slowdown in economic growth.

A lower currency is helping Australia to weather the storm as falling commodity prices weigh on export revenue. Demand from China, Australia’s largest trading partner, is expected to continue to slow and the glut of iron ore, the country’s top export, is expected to remain as top producers ship record amounts to compensate for lower prices.