Forex Investment and Currency Trading

Australia: Rate Cuts Looming as the Economy Stalls

• The RBA remains on track to deliver an interest rate cut during the December quarter. The first move may be a 50bp cut in line with the start of previous easing cycles.
• The monetary policy easing cycle is likely to deliver 125 to 175bps of ratr reductions by the end of 2009. The cuts will be more than this if the commodity price bubble bursts within the next year.
• As a result, the AUD is looking vulnerable to the downside, despite booming commodity prices. Flat GDP, an erosion of the interest rate gap and a global slowdown present a problematic outlook.
• The short end of the Australian yield curve looks to be presenting rare and extreme value, be it in bonds, swaps, a spread or a steeper curve.

TRADE IDEAS:

• Sell AUD/USD on the expectation it will trade below US$0.90 in the second half of 2009.
• For a short term trade, sell AUD/NZD on the possibility that Australian data will prove to be as bad, if not worse, than in New Zealand data. Target 1.1600.
• Receive short dated swaps (receive 2 years – target 7.30%), buy Australia 10 year bonds vs Canada and have a curve steepener (2s / 10s in swap which is currently at -44bps with a target of +20bps).

With retail spending probably in recession and the whole Australian economy not far behind, the RBA remains on track to begin a cycle of interest rate cuts during the December quarter.

The recent data flow in Australia shows a text book example of how monetary policy works. With the RBA hiking rates over the past 6 years and monetary conditions tightening precipitously, retail sales are now falling in real terms, consumer sentiment is hovering at recessionary levels, credit growth has decelerated abruptly, business confidence has been driven to levels consistent with a general economic hard landing and housing activity has stalled.

Add in to the picture falls in business investment, a flat inventory position, a slowing in profit growth and some moderate tightening in fiscal settings, and the circumstances pointing to a protracted period of subdued activity is close to a nobrainer.

While there has been a lot of data in recent days to lock in the slow down story and open up the opportunity for monetary policy easings, there is still a lot of data over the coming 10 days or so. News on GDP, building approvals, international trade, job advertisements, business confidence, consumer sentiment and employment will provide plenty more information on the growth and inflation risks.

It is very much misguided to think the RBA will deliver an interest rate hike(s) in a climate of stalling growth and probable easing in inflation once the normal lags (between slower GDP and then inflation) work through the economy. At worst, the RBA will leave rates steady for the next little while as it patiently waits for the lags to register with the inflation data. At best, rates will be cut as the RBA looks over the horizon to higher unemployment and a deceleration in inflation and the possibility of a hard landing for the economy.