AUD/USD has taken a battering over the pat 7 days, there were several small event risks that triggered the collapse such as; news China delaying (not cancelling) coal imports from Australia, that a second wave is taking hold in Europe and that the third COVID-19 stimulus bill probably won’t pass the House before the November 3 Presidential election.
However, the acceleration in the decline at the back end of the week was clearly due to Governor Philip Lowe’s speech around the outlook for the cash rate and the future for further policy intervention.
First of all, there were several major announcements about the Board’s ‘targets’ and the future of the cash rate, this can summarised with this statement “The RBA will not raise rates until actual (not forecast) inflation is sustainably in the 2-3% target band.” This is clearly years away.
The Board has also changed tact around its ‘core mandate’ with unemployment taking over from inflation after Lowe stated that lower unemployment is an “important national priority”, full employment according the RBA is unemployment around 4.5%.
All in all, the RBA believes rates won’t raise for at least 3 years, most likely longer looking at those new targets.
So, rates are not raising but could they fall further?
The Governor outlined that possibility in three debate points:
1st would cutting further be ‘effective’? The Boards conclusion is yes once mobility restrictions ease. This has led 7 investment banks to forecast a 15-basis point rate cut on the 3rd of November. Catch is the market had already priced in that move as seen here with the overnight rates market.
At 0.13% the AUD has been pricing this in for over 3 weeks. So should not have been the reason for the downward movements seen.
2nd What is the impact on financial stability? The Board’s belief is that at this point in the cycle the positive of more jobs probably outweighs the negatives on risk appetite.
3rd What’s happening overseas, and could we be doing similar here? In short, they are doing more and yes, we should follow. The Boards view is that it needs to focus on balance sheet size and longer-term yields and implicitly the AUD. This is the key point of traders, the RBA is about to add quantitative easing (QE) to the Australian lexicon. It is likely to target the 5- and 10-year bond at 0.5% similar to how it targeted the 3-year bond at 0.25%.
This has seen the Australian-US 10 year spread hit 0.03% and is likely to invert once the policy is enacted as this chart shows. That an immediate AUD negative.
Now timing around possible movements is up for debate as the Governor did use vague terms like “The Board will continue to review these and other issues at our upcoming meetings.” So, there is a risk November may not happen but in terms of the AUD’s movements it is certainly starting to price in the probability.
It makes the next 2 weeks of trading very interesting.