- AUD creeps higher Thursday but faces losses over coming days.
- Westpac eyes decade-low for AUD/USD as RBA cuts rates again.
- Says market not prepared for Tuesday cut, strong USD to also weigh.
- UBS forecasts RBA cash rate of 0.25% by end of May next year.
The Australian Dollar crept higher against many rivals in the morning session Thursday but is being tipped as vulnerable to fresh losses over the coming days, with strategists at Westpac saying the market is unprepared for a likely Reserve Bank of Australia (RBA) interest rate cut next week.
Reserve Bank of Australia Governor Philip Lowe will announce the next interest rate decision at 05:30 next Tuesday and Westpac, one of Australia's four largest lenders, is forecasting a further cut to the bank's benchmark of borrowing costs from 1% to 0.75%. But the bank has also warned that investors are not fully prepared for this move.
The overnight-index-swap market, which enables investors to protect themselves against as well as speculate on changes in rates, implied on Thursday an October 01 cash rate of 0.80%. That's above the 0.75% that'll prevail if the RBA cuts Tuesday and suggests that some are unconvinced it will.
"We are comfortable with our long-held call for the RBA to cut the cash rate to 0.75% on Tuesday. A rate cut is about 75% priced, so A$ seems vulnerable to further decline," says Sean Callow, a strategist at Westpac. "Risks to AUD/USD are of 0.6700 and below on the week but not necessarily on a daily close basis."
Callow's tip of 0.67 or below for the AUD/USD rate would put the Antipodean currency at its lowest level for a decade and, in the unlikely even the GBP/USD rate remains around its current 1.2350 until after the RBA meeting, could see the Pound-to-Australian-Dollar rate rise above the 1.84 handles, from 1.8250 Thursday. However, increasing numbers of pundits are warning that Brexit headlines could push Pound Sterling lower over the coming weeks.
Westpac's warning comes barely two days after the RBA's Lowe hailed a perceived turning point for the Aussie economy in a speech to the Armidale Business Chamber. The comments were the latest in a growing line of remarks that have repeatedly shifted the currency market's thinking on the outlook, with traders this time seeing them as indicative of a pause in the cutting cycle.
"To us, this was a misunderstanding of the speech, driven by Lowe’s (NYSE:LOW) optimism that “a gentle turning point has been reached” for Australia’s economy. He has said this before," Callow says. "Lowe also spent considerable time on the rise in the unemployment rate (see chart) and not coincidental stalling of wages growth. Moreover, he made clear that the downward pressure on global interest rates could not be ignored – to do so would mean A$ “would appreciate, which…would be unhelpful.”
The RBA has cut rates twice in 2019 in the hope of meeting its inflation target by using lower borrowing costs to stoke faster economic growth. But the cuts have ensured that the gap between Australian and U.S. interest rates, which turned in favour of the U.S. Dollar during 2018 and reached a peak of 1% at the end of that year, has remained just as wide as it was despite the Federal Reserve also has reduced U.S. rates twice now.
That's put pressure on the Aussie relative to the U.S. greenback by reducing its attractiveness in the eyes of investors. Australia's Dollar has been backed since its 'flotation' by interest rates that were typically higher than those elsewhere in the developed world, but those days are now over and a rate cut next Tuesday will hammer that point home again by putting the Aussie cash rate on a par with the equivalent rate of the Bank of England, which is 0.75%.
"The broad US dollar trend is also likely to weigh on AUD/USD, with US data momentum improving and Fed officials trying to stress the positives on the domestic economy," Callow says, in a note to clients Thursday. "Pricing for a 30 October rate cut has slipped to about 50/50. We will see whether this remains the case after the US employment report on 4 Oct, but for now, DXY should enjoy more solid yield support."
Changes in rates are normally only made in response to movements in inflation, which is sensitive to GDP growth, but impact currencies because capital flows tend to move in the direction of the most advantageous or improving returns. Those flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from the currency.
Inflation has been below the 2%-to-3% target band for years now and with the commodity-dependent and China-exposed economy slowing, amid a litany of domestic challenges, the RBA has for more than a year watched its target slip further and further from view. The bank says developments in the jobs market are key to lifting inflation, with lower unemployment and resulting in higher wage growth both prerequisites for attaining the target.
The rub for the RBA is that unemployment has risen from 4.9% to 5.3% in 2019, with the latest increase coming just in August, and wage growth is now heading in the wrong direction. This, as well as woes for the Chinese and global economies, could mean the RBA is forced to cut rates again after next week.
"This data is very challenging for policymakers. Jobs growth is entirely driven by the public sector booming, but private jobs dropped to ~flat, & lead indicators suggest weakness ahead. Furthermore, home prices & loans are reflating, but construction jobs & activity are about to slump. We still expect the RBA to cut in Oct/Feb/May to 0.25% has said," says George Tharenou, an economist at UBS.