RBA on hold, but not for long

Thought of the day

by Chief Investment Office 03 Dec 2019

The Australian dollar (AUD) is up 1.4% versus the US dollar since Friday’s close, making it the second-best performing G10 currency this week. The move up has been spurred by stronger-than-expected PMI data from China and a weaker USD following disappointing US ISM manufacturing data. Traders also piled into the Aussie dollar thanks to the country's record current account surplus in 3Q19 and to today's central bank policy statement that indicated domestic growth has likely bottomed.

But we stay underweight AUD in our FX strategy for the following reasons:

  • The RBA remains biased toward easing. After cutting rates three times this year, the Reserve Bank of Australia (RBA) kept the cash rate unchanged at 0.75% today (as expected) but retained a clear easing bias. The policy statement stated that, “the Board is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time." RBA Governor Lowe also recently flagged the effective lower bound for cash rate is 0.25%, below consensus' forecast of around 0.5%, and mentioned the RBA may consider quantitative easing if it thinks it won't meet its objectives.
  • Incoming data suggest further deterioration in economic activity. Australia's headline manufacturing PMI moved into contraction in November, for the first time since the start of the survey in May 2016. Residential buildings approvals are down near the seven-year low of 157,000, real imports fell further in 3Q19 after contracting in 2Q, and private sector credit growth in October was the weakest since 2010. This points to continued weakness in private spending and disappointing 3Q19 GDP data (due tomorrow), likely leading the RBA to again downgrade its growth estimates for 2020 at the February meeting.
  • Proxy for China growth. Our base case is for a US-China Phase 1 deal in the coming weeks, but no comprehensive agreement before the 2020 US presidential election. Chinese growth is set to ease further in 2020, and we expect additional stimulus next year to be modest and targeted. We expect iron ore, coal and liquefied natural gas to remain well supplied, putting prices of these commodities under pressure. This suggests that Australia's terms of trade peaked in 3Q19.

So, while AUD has jumped this week, we think near-term downside risks should not be underestimated as domestic factors are likely to trigger at least one more cut to the cash rate cut by mid-2020. In addition, we expect the discount of Australian government bond yields versus US yields to persist next year at around 60–80bps, which should keep net positioning short AUDUSD. In our FX strategy, we remain underweight the AUD versus the USD.

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