Reserve Bank Of Australia Downgrades Economic Conditions, Eyes Lower Currency

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I expected the Reserve Bank of Australia (RBA) to stand pat on rates in its latest statement on monetary policy. Instead, the RBA cut rates by 25 basis points to 3.25% and, in the process, the RBA clarified that it is indeed interested in working the Australian dollar (NYSEARCA:FXA) lower in the face of weakening global economic conditions. The RBA concluded its statement by saying (emphasis mine):

"…credit growth has softened of late and the exchange rate has remained higher than might have been expected, given the observed decline in export prices and the weaker global outlook.

At today's meeting, the Board judged that, on the back of international developments, the growth outlook for next year looked a little weaker, while inflation was expected to be consistent with the target. The Board therefore decided that it was appropriate for the stance of monetary policy to be a little more accommodative."

Overall, the RBA seems to have backed off from its more optimistic assessment of the Australian and Chinese economies that I read in the minutes from the previous statement on monetary policy. This latest statement began without mincing words:

"The outlook for growth in the world economy has softened over recent months, with estimates for global GDP being edged down, and risks to the outlook still seen to be on the downside…Growth in China has also slowed, and uncertainty about near-term prospects is greater than it was some months ago."

I have duly noted that the RBA is likely no longer claiming that China is simply experiencing a soft landing.

Moreover, the RBA seemed to imply in this statement that there is some sizable chance that the non-mining sector will not be ready to pick up the anticipated slackening in the resource sector next year (emphasis mine):

"Looking ahead, the peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected. As this peak approaches it will be important that the forecast strengthening in some other components of demand starts to occur…The Bank's assessment…is that the labour market has generally softened somewhat in recent months."

The upshot of these downward revisions is a more bearish outlook on the Australian and the global economy. Traders will likely increase shorts on the Australian dollar over the next few days, ready to oblige the RBA's desire for a lower currency. However, the rate differential remains wide compared to all the near-zero to zero rate alternatives, At some point, the weakest of this set - the euro (NYSEARCA:FXE) - will likely return to its new role as a funding currency for buying Australian dollars. As such, my preferred way to short the Australian dollar remains with the British pound. I still like shorting the euro with the Australian dollar and intend to maintain a small position for as long as it is practical. (I closed out my latest long GBP/AUD into the post-RBA surge as I now want to see the pair confirm a breakout).

The British pound appears ready to break out against the Australian dollar


So with the RBA's latest statement, I increase my bearish position from marginal to "mild." I still cannot get aggressively bearish because there is simply no way to tell when long-range buyers will decide to scoop up cheaper Australian dollars for yield. As Geoffrey Yu, foreign exchange strategist at UBS, explains in the October 1st edition of "Hard Currency," rate cuts will make little difference to the yield chasers who are leery of all the quantitative easing and monetization of debt occurring in other major economies well beyond the Aussie shores.

Finally, given the tight correlation between the S&P 500 (SPY) and the Australian dollar, my shift in bias also implies that I will be shifting toward a bearish bias against the stock market in the near-term.

Be careful out there!

Full disclosure: short EUR/AUD

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am short EUR/AUD as explained in this piece.