RBA governor: "The [Australian] economy is likely to be operating with a degree of spare capacity for some time." Photo: iStock
First, a quick look at the major data point of second-quarter GDP. Economic growth was weak over the three-month period ending June 30, coming in under market expectations at 2% year-on-year, well below trend (a surprise to economists maybe, but not to the Reserve Bank of Australia: the number matched their forecast in the August 7 Monetary Policy Statement).
Market reaction was muted, with AUDUSD
briefly slipping under 0.70 cents for the first time since 2009 before recovering. Money markets maintained a 100% chance the RBA will cut its 2% policy rate by 25 basis points by year end.
The quarterly GDP number usually comes out the day after the RBA board has one of its regular monthly meetings to discuss monetary policy. You would think it would be a good idea to delay the meeting for one day so as to have the latest information to hand, but apparently not.
Regardless, with the number in line with RBA expectations, Governor Glenn Stevens' post-board meeting statement had already accurately summed up the situation: “Overall, the economy is likely to be operating with a degree of spare capacity for some time yet, with domestic inflationary pressures contained”.
We are not likely to get much more comment out of the RBA on the economic situation until their November 6 Monetary Policy Statement, which will include updated economic forecasts. But with the money markets fully pricing in another rate cut by year-end, there is a suspicion the RBA is a little behind the curve.
In the meantime, FX traders will look to the usual suspects – China
and commodity prices – to give impetus to the AUDUSD
RBA content with currency
Tuesday’s monetary policy statement repeated the new mantra the RBA seems to have adopted when referring to the exchange rate: “The Australian dollar is adjusting to the significant declines in commodity prices”.
Gone are previous attempts to jawbone the Aussie lower. Perhaps by crying wolf the bank thought there was a risk things could get out of hand and the Aussie might collapse, in a similar fashion to the infamous “banana republic” episode in the mid-1980s.
But a glance at the following two charts suggests there is a good case for the exchange rate to “adjust” a lot more yet. Chart one shows that the relentless decline in commodity prices has sent the terms of trade index under its 2009 level.
A country’s terms of trade are no different from yours or mine in our own businesses. I “export” my FX forecasting service. If the US dollar price I receive from subscribers goes down, while the costs of producing the service hold steady, then my “terms of trade” have declined and so has my income. What would save the day for me – and other exporters – is if the AUDUSD exchange rate declined so that my income in Aussie dollars doesn’t change.
Yet Australia’s exchange rate, as measured by the trade weighted index (TWI), is still well above its 2009 low and the real (i.e. inflation-adjusted) rate has a lot of catching up to do, as shown in the chart below.
Source: Reserve Bank of Australia
However, the two charts show the Aussie dollar is highly correlated with commodity prices (especially evident when comparing it with the CRB commodity index over time). The key iron ore price stabilised over the $50/tonne mark recently but the supply/demand dynamics suggest this will be temporary. A resumption of the downtrend would take AUDUSD down with it.
What’s China’s game plan?
Although Tuesday’s monetary policy statement suggested the RBA was relaxed about the current level of the Australian dollar, Stevens will be watching events in China closely. The yuan makes up almost 30% of Australia’s trade weighted index, so any developments on that front will have a significant impact on the index.
This hasn’t been a problem in recent times, with the Chinese currency linked to the US dollar, but it seems we are entering a brave new world where previous linkages can no longer be relied on. And, as this chart shows, devaluation against the US dollar has not been sufficient to correct the big run-up in China’s nominal effective exchange rate (its TWI, in other words).
So the People's Bank of China
will want to see the yuan weakening against other trading-partner currencies like the yen and euro. The Aussie will also be expected to do its part. Therefore, the RBA may find itself in a situation where AUDUSD is declining but the trade weighted index is going up, supported by a rising AUDCNY.
Source: Reserve Bank of Australia
The Reserve Bank of Australia is holding its cards close to its chest in the face of below-trend economic growth, declining commodity prices and uncertainty over just what China’s exchange rate game plan is. Weighing up the situation, money markets are confident the bank will have to deliver another rate cut by year-end. All up then, it looks like the path of least resistance for AUDUSD is down.
My Technical Analysis (Elliott Wave) of AUDUSD is presented below. If you would like more
detailed trading advice then let me know.
Chart: AUDUSD weekly chart (click to expand)
Chart: AUDUSD daily chart (click to expand)
Source: ThomsonReuters. Create your own charts with SaxoTrader; click here to learn more.
– Edited by Susan McDonald
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Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.