Article / 29 June 2016 at 1:54 GMT

Australia's election a sideshow to main event for AUDUSD

Managing Director / Technical Research Limited
New Zealand
  • The RBA holds its monthly policy review meeting next Tuesday
  • It will be the first central bank to comment on Brexit influences
  • Post Brexit, the odds of a rate cut have jumped from near zero to about one-in-three 
  • If that chance becomes a reality, AUDUSD would be hit

By Max McKegg

The dust appears to be setting on Brexit, at least in the short term, so AUDUSD traders can concentrate on the two domestic events likely to drive the cross over the next week. 

 Welcome to AUDUSD's main event: the RBA's policy review meeting 
next Tuesday. Source: iStock

First up is the Australian general election on Saturday where Prime Minister Malcolm Turnbull’s Coalition government faces off against the Bill Shorten-led Labor Party. Those who abide by the “follow the money” rule (which failed so spectacularly on Brexit) will notice the bookmakers have the Coalition at $1.10 and Labor at $7.00, thereby making the outcome look like a done deal.
When a conservative government wins re-election, the markets usually reward it with a rally. However, in Australia – as in many Western democracies – the day-to-day management of the economy was long ago contracted out to the central bank with the government left to manage the budget. 

The budget is in deep deficit but neither the Coalition nor the Labor party are proposing policies that offer the prospect of a return to surplus within five years. Thus public debt will continue to rise no matter who holds the reins of power after Saturday. Nevertheless, the ratings agencies don’t seem concerned and Australia’s AAA rating looks secure.
Therefore with the odds heavily in favour of the government maintaining its majority, and not much change in economic management even if there was an upset, we can be reasonably confident any movement in AUDUSD will be modest when the markets open Monday morning.
The real power to influence markets lies with the Reserve Bank of Australia. The Bank’s board holds its monthly policy review meeting next Tuesday. Post Brexit, money market pricing suggests the odds of a cut to the 1.75% official cash rate at this meeting have jumped from close to zero to about one-in-three. Prior to Brexit, markets expected the RBA would wait until August to deliver a cut that had been incorporated into the economic forecasts it presented in the May Statement on Monetary Policy

The advantage of waiting was seen to be that the June quarter inflation update would be available on July 27 and could be taken into account in the Bank’s updated forecasts in the August Statement.
The economy is projected to grow close to its potential over the next couple of years and commodity prices are consolidating at low levels, as is the AUD. On that basis there is no need to cut rates further. But the inflation outlook has taken a turn for the worse, as shown in this chart.

Source: Reserve Bank of Australia

The May forecasts issued by the RBA implied that a 25 basis point cut in the 1.75% policy rate would be required to put things back on track to the 2-3% target band. The question was: when to deliver it? In light of Brexit developments, the Bank’s board will be debating whether to do so sooner rather than later – and that means next Tuesday is “live”.
AUDUSD was collateral damage to Brexit, but the RBA is more concerned with its overall value as measured by the Trade Weighted Index. As this chart shows (click to enlarge) AUDGBP is well down the totem pole when it comes to influencing the TWI. 

So even if GBP remains under pressure, the TWI is unlikely to rise much from here. Hence the RBA will be relaxed about its current level, meaning the exchange rate will not be a key factor in its decision on Tuesday.

Source: RBA; Metastock
What may be a factor, however, is the attractiveness of Australia’s yield curve when the red ink of negative rates is spreading across the globe. The return on the 10-year government bond has just slipped under 2% but, as this graphic demonstrates, relative to other options, 2% on a AAA-rated credit looks good, a point not lost on real-money investors who continue to buy in.

 Source: Pension Partners

The general election on Saturday looks a done deal so will have little impact on AUDUSD apart from a small relief rally. That event is a sideshow to the real game in town: the Reserve Bank of Australia’s policy review meeting next Tuesday. 

The RBA will be the first central bank to make a formal comment on how Brexit is likely to influence local economic conditions. Market pricing incorporates a one-in-three chance of a rate cut this time around, but if that chance becomes a reality, AUDUSD would be hit, especially if low-risk appetite was continuing to support the USD at the time.

– Edited by Gayle Bryant

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform. 


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