The bond market pricing for a Reserve Bank of Australia (RBA) rate cut on 3 November jumped from below 30% to 61% after Australian Q3 CPI came in below expectations. The Aussie dollar instantly dropped a full 1% down to US$0.7120 as the algos saw the headline CPI print come in at 1.5% year-on-year below the expected 1.7% and went on a pre-programmed selling spree. But after the initial algo exuberance, the Aussie did not look to be recovering much of its fall seeing only a very light lift off the $0.7120 level.
It is hard not to argue that the CPI release was very weak. The Trimmed Mean CPI measure (which excludes the items with the largest increases and decreases) was expected to rise to 2.4% year-on-year, but actually came in at 2.1% declining form the previous quarter’s 2.2%. The expectations for a 1.7% year-on-year increase for Q3 CPI was largely consistent with where the unofficial monthly TD inflation gauge was tracking.
And yet, CPI increasing at 1.7% does seem somewhat inconsistent with a quarter where we have seen the biggest global equity selloff since 2011. Alongside this global equity sell off we have seen oil prices spend a significant period below the US$40 level during the quarter. Even though the Aussie dollar lost a further 9% during Q3, the prices of a huge range of goods saw their prices drop in the period as concerns over global demand weighed on markets. This is clear in the data with the biggest fall seen by vegetables (-5.9%) and automotive fuel (-1.7%).
Earlier this year we saw Australia’s unemployment rate blow out to 6.3% and the RBA were happy to look through this, and the big question is whether the RBA will be prepared to look through this again. Even though there does seem compelling reasons for the RBA to cut rates, the Glenn Stevens’ RBA is not one to move early or be pressured by the market. And certainly in all of the recent RBA statements and minutes there has been no indication that the central bank was mulling rate cuts.
It does look like a tight call, but if the market have got it wrong on a November cut by the RBA there does seem to be significant upside to the AUD/USD, particularly if the Fed definitively push rate hike expectations into 2016 at tonight’s meeting.
Another key facet will be the Reserve Bank of New Zealand’s (RBNZ) decision at their meeting tomorrow. If the RBNZ do unexpectedly cut rates again, then expectations will only increase for the RBA to cut rates. However, the market and the vast majority of economists are calling for them to leave rates on hold. And in the event of Fed rate hike expectations being pushed out into 2016 and the RBNZ leaving rates on hold, it does seem likely that the Aussie dollar is set for a bit of a bounce over the next 24 hours.