Falling AUD is fine, collapsing isn't

The Asian session today was dominated by the Reserve Bank of Australia (RBA) policy statement, which marked a major shift in the bank’s view on the AUD, although when viewed in the light of the Fed moving towards rate hike, the change in the language is hardly surprising.

AUD is adjusting to the slump in commodity prices – RBA

The policy statement carried a major change in the language with regards to the AUD. The bank now states that the Aussie is adjusting to the slump in the commodity prices as against the previous language which said further depreciation in the AUD is both “necessary” and likely. The FX markets welcomed the change in the language by sending the Aussie higher across the board. Now questions are being raised if the Aussie will stay sideways due to the change in the language or the interest rates will be on hold.

Major shift even though fundamentals likely to remain unchanged

China is not out of the woods yet with increasing calls for further slowdown in the days ahead. The Chinese stock markets are being supported by restrictive measures, while the investors are forced to sell Gold in order to fund stock market losses. Crude prices are on the losing trend once again, which will further drive metal prices lower. Consequently, iron ore and other metal prices are unlikely to see anything more than a minor technical correction.

Still, the RBA statement today carried a major shift in the language. The bank no longer sees further depreciation “necessary”, although the likelihood of further depreciation is still intact even if the bank no longer attests to it. Then why is the shift in the language?

RBA and other central bankers confirm Fed rate hike…

The RBA’s decision to change language today is in line with a similar move adopted by the RBNZ and growing calls from the BOJ members that further monetary easing is not required at the moment. The RBNZ, on July 28th, said a weaker NZD is necessary, but played down rate cut expectations. RBNZ governor Wheeler said, “Some local commentators have predicted large declines in interest rates over coming months that could only be consistent with the economy moving into recession. At this point, we believe that several factors are supporting economic growth.” Meanwhile, there is growing chatter off-late from Bank of Japan policy members that further monetary easing at this moment is not required.

Moreover, the shift in the view on their currencies despite weak fundamentals indicate the banks are worried about the collapse of their currencies, especially as the Fed is on the path to hike rates this year. So far the Fed has not given a clear cut hint at the timing of the rate hike, despite which the relative policy divergence has punished currencies like AUD, NZD, CAD, JPY. Once the Fed hints at a rate hike this year, the last leg up in the USD shall play out. Consequently, the commodity currencies are at a risk of a collapse in case their central banks stay hold bearish views on their respective currencies.

Thus, a shift in the language by the RBA, RBNZ, BOJ states the central banks are comfortable with a fall, but not with the collapse of their currencies, while indirectly confirming that the Fed is indeed likely to raise rates this year. Hence, it is safe to predict that further rate cuts from the RBA, BOC and other major central bankers are unlikely ahead of Fed rate hike.

What it means for the AUD

• The correction to 0.7770, which is the 23.6% of the plunge from 2014 high to 2015 low appears difficult given the Fed rate hike possibility and weak fundamentals.

• However, a rise to 0.7454 (23.6% of May high to July low) could be seen. A break above the same could open doors for 0.7533 (Mar low). Any move above 0.7533 is likely to be utilized by the markets to initiate fresh offers ahead of the fed rate hike.

• A range bound activity – 0.2-0.76 - is expected till the Fed refrains from giving a clear cut hint at a rate hike. The last leg higher in the USD could lead to a downside breakout from the range once the Fed hints at a rate hike. The change in the RBA’s language today is likely to avoid the fall turning into a collapse.

• The change in the RBA language makes it a favoured currency against the CAD as the BOC is yet to announce a shift in its language on the AUD. Furthermore, the CAD is more vulnerable to the drop in the crude prices. The Aussie would also be attractive on days of weak UK data since the GBP/AUD is overbought on the charts.