Time to swivel heads around on the Australian dollar (FXA) yet again.
In "Australian Dollar's Relief Rally Ends With The Latest RBA Meeting Minutes," I concluded that the Reserve Bank of Australian (RBA) signaled it is willing to continue cutting rates until the Australian dollar drops to more acceptable levels. Now, I am not so sure as this week's statement on monetary policy excluded the critical cover that the RBA has used to signal the potential for lower rates.
From July's statement which featured no change in the cash rate:
"The Board also judged that the inflation outlook, as currently assessed, may provide some scope for further easing, should that be required to support demand."
From August's statement which featured a cut in the cash rate by 25 basis points:
"The Board has previously noted that the inflation outlook could provide some scope to ease policy further, should that be required to support demand."
September's statement said absolutely nothing about scope and did not reference the outlook for inflation. The RBA only stated that inflation "has been consistent with the medium-term target." Implicitly, the RBA seems to be suggesting that the cash rate target has gone as low as it can given current inflation (and the outlook). I almost missed these subtle changes. I only caught them after I decided to graph out some Australian economic indicators to provide a visual on some key inputs into the RBA's decision-making. After realizing the cash rate is now roughly equal to the current inflation rate, I reviewed recent statements for commentary on inflation.
The changes were so subtle (to me) that I even tweeted right after the release that the RBA provided absolutely no new news in its latest statement. I was clearly wrong, and I think this is potentially important news for trading the Australian dollar in the coming days and weeks.
For reference, I have created a chart using data from the statistical tables referenced by the RBA (using data to Australian Bureau of Statistics). It juxtaposes the unemployment rate (reported monthly), the cash rate target (changed periodically), the annual CPI rate (seasonally adjusted and excluding volatile items) (reported quarterly), and the real gross domestic income (seasonally adjusted and reported quarterly). I used the real GDI because it is an adjusted measure of GDP "…calculated by adjusting gross domestic product for the effect of the terms of trade. The terms of trade is the implicit price deflator of exports of goods and services divided by the implicit price deflator of imports of goods and services." Moreover, over the past year or so, the RBA has been quite "vocal" in pointing out that Australia's terms of trade have peaked. I have converted the CPI and real GDI into year-over-year changes.
Various Australian Economic Indicators
(January, 2007 to August, 2013)
So, the cash rate target (thick red line) is now roughly equivalent to the inflation rate (green line). There appears to be no further "scope" for lower inflation. The August GDP print further confirms that the economy is not collapsing, making it unlikely that inflation is about to fall much further. Also note how the unemployment rate (blue line) has slowly crept back up to levels last seen in the wake of the financial crisis. Clearly, the RBA has been trying to get ahead of this decline with its rate cuts. Finally, after declining for over two years, the real GDI appears to be stabilizing with a consistent rebound over the last 9 months or so. In other words, indicators seem to be converging for now on a halt to the RBA's cycle of rate cuts. At a bare minimum, a new catalyst appears lacking. The Australian dollar has responded by another rebound. This one looks more sustainable than the previous relief rally as key technical levels are giving way against several major currencies.
AUD/USD bounces without making a lower low
A breakout above the 50DMA could signal a bottom in the making for AUD/JPY
The uptrend in GBP/AUD remains intact for now
An important retest of recent lows for EUR/AUD
Source for charts: FreeStockCharts.com
Trading the Australian dollar now gets very tricky. I believe the RBA still wants a much lower currency even if it no longer has the data to justify rate cuts to instigate such a decline. This means that the next few months could feature much more jawboning of the likes we have seen recently from Governor Glenn Stevens. For now, I am using the current rally in the Australian dollar as an opportunity to gradually accumulate a fresh (net) short position at good prices. I think there is still enough geo-political risk and economic uncertainty in the air to justify fading this rally. However, time could actually be running out on shorts, and I strongly suspect the next pullback in the Australian dollar will not print new lows for the currency. As always, time will tell…
(Of course, the coming elections may be a wildcard, but I am not in a position to connect the political dots to the economic ones in Australia. The Economist recently produced a short but educational video on this topic. See "Australia's election: An unappealing choice. When the luck runs out").
Be careful out there!
Additional disclosure: In forex, I am net short the Australian dollar (short-term)