RBA rate cuts are blunt instrument in arresting AUD strength

By:
Russell J. Dinnage
Published on:

The Reserve Bank of Australia (RBA) is going to have to do a lot better than a 25-basis-point cut to the benchmark interest rate if it hopes to provide some impetus to an economic engine that seems to be running out of steam.

In cutting the Australian benchmark interest rate to 3.25%, the RBA is hoping it can head off the deteriorating outlook from the Chinese manufacturing sector, and offset the impact of QE3 on the USD, both of which are creating something of a squeeze on the domestic economy.

While a 25bp cut will hardly move the dial – the AUD fell to $1.03 in trading on Tuesday – FX strategists say the RBA has no choice but to continue cutting interest rates if it wants to force the AUD to hit parity, which it last did in June.

An inconsistant message

How effective they will be with that is a moot point. The issue for the market is that reading the RBA on its monetary policy bias has become a game of pot luck, rather than one of calculated perception.

According to Olivier Desbarres, head of FX strategy for Asia-Pacific at Barclays, the RBA is sabotaging its efforts to weaken the AUD by failing to be predictable about interest-rate cut decisions.

He says the interest-rate market for Australian rates is constantly "swinging about", pricing in anticipated RBA rates cuts as quickly as it prices them out.

"You get this kind of tidal effect for the Australian rates market, which is only exacerbated by uncertainty over RBA decision-making," says Desbarres. "The central bank constantly exacerbates that volatility by surprising the market and often going against consensus."

In September, for example, the RBA was widely expected to cut interest rates, but it held back. Only eight out of 28 economist surveyed by Bloomberg forecast Tuesday’s rate cut.

Meanwhile, some strategists say the RBA needs to cut a further 100bp to 250bp to affect the fundamental value of the AUD by the end of 2013. The OIS curve, which tracks forward interest rates, is pricing in a 75bp cut in the rate by March.

Desbarres says continued RBA interest rate cut decisions are the main weapon the central bank has in its arsenal going forward as FX intervention is unlikely.

The RBA will continue to do what it thinks is right for the Australian economy irrespective of what analysts may price in based on perceptions of the central bank's appetite or lack thereof for rates cuts, says Desbarres.

Royal Bank of Canada head of G10 FX strategy Adam Cole says if further RBA interest-rate cut decisions fail to weaken the AUD further, then it would be forced into a situation of being explicit about AUD and its role in determining monetary policy.

"If the RBA said interest rates will fall because of the strength of the AUD, then that might cause the currency to depreciate," says Cole. "But it would be very un-RBA-like to make a statement like that, as they typically have a very laissez-faire attitude toward the AUD."

That is a situation the RBA may not be willing to confront, given the fact in recent times the AUD has been less responsive to interest-rate cuts as other higher-yielding G10 currencies, because of its key attribute as a liquid risk-on currency.

Cole says the downside for the AUD through the end of this year and into Q1 2013 is "very limited", because 80% of daily variation in the value of the AUD is risk-on appetite for the USD.

"As long as the Fed is backstopping risk appetite, then it is difficult to be bearish on currencies that traders take risk from, and the AUD is one of the keys for that equation," says Cole. "As long as the market is buying risk, I would be buying AUD as well."

Technicals go bearish

However, Commerzbank head of FICC technical analysis research Karen Jones says the FX market should not become irrationally exuberant about AUD strength being a long-term sure thing.

Jones says technical signals are in place for the AUD to slip below parity with the USD in Q1 2013, and that Tuesday’s rates-cut decision was a key technical moment for the Aussie.

Jones says she is forecasting AUDUSD will hit around $0.9750 by Q1 2013.

 AUD turns bearish in spite of rate cut sceptics
 

source: Commerzbank

"The AUD is failing at the top of a converging range, which suggests longer term that we are heading to the base of this converging range," says Jones. "I’m looking for the 55-week moving average of $1.0290 to be eroded, with losses down to $1.0167, and eventually, for the rest of the quarter, I am looking for a move sub-$1.00."

Whether the AUD is able to break from the base of its convergence range all depends on a trader’s bullishness or bearishness on the USD long-term, says Jones.

"It’s hard to tell if the AUD would break from the bottom of its range quickly, but my feeling is that the market remains bullish USD long-term," says Jones.