RBA Cuts Cash Rate to Record Low to Spur Inflation

The Australian dollar fell more than 35% against the U.S. dollar over the last 5 years, and despite some major events from the U.S. in the last couple of years (including the end of the quantitative easing program by the Federal Reserve in October 2014 and the Fed decision to raise interest rates after a decade, which helped the U.S. dollar to gain value), the RBA’s central bank actions also weighed down on the Aussie.

Of particular importance to AUD-traders is whether the RBA will cut interest rates below the 1.0% mark at some point in the near future. The RBA lowered its main interest rate for the second time this year by 25 basis points to a fresh record low of 1.50% during the meeting held on August 02. Even though that is a record-low for Australia, it is one of the highest in the developed world and much higher than rates in the U.S., U.K., and the Euro area. However, any further cuts to interest rates by the Reserve Bank would be a negative for the Australian dollar.

The main reason that drove RBA to reduce rates to a record low was an effort to boost core inflation, which fell further below its target of between 2% and 3% to a record 1.0%. Inflation concerns will be a major driver of the domestic currency sentiment through Q4, if not beyond. By lowering further its interest rate, it should weigh negatively on the Australian dollar as it attempts to rebalance away from mining. However, following the last two rate cuts by the RBA, it appears that they didn’t have any dampening effect on the demand for the Australian dollar, and as a result it continues its ascent and looks a lot stronger since the last rate cut.

As we mentioned above, another factor that played a major role in Australia dollar’s appreciation was the slower than expected path of rate hikes from the Federal Reserve. The U.S. economy appears to be gathering pace in the second quarter of 2016, raising investors optimism about the U.S. growth prospects in the second half of 2016. While we still expect the Fed to raise interest rates in the remainder of the year, we have scaled back our expectation regarding the pace of hikes, and expect a rate increase by 25 basis point until the end of 2016. This should still give support to the U.S. dollar.

fig 5 AUD, Bulls, Back, Command, For How Long,, Currency Analysis, fx trader, forex

Figure 4. AUD/USD Spot Price vs Interest Rates

Technical Snapshot: AUD/USD

From a technical standpoint, the Australian dollar’s bear market is still intact on the weekly timeframe. As I’ve discussed before, the AUD/USD pair has been falling since mid-2013 and has been forming lower highs and lower lows over the past three years, as it fell more than 35% the last five years. For the medium and long term traders, the technical picture according to the weekly and monthly timeframes present a bearish tone, since, on the monthly timeframe, the 50-SMA crossed below the 100-SMA. On the same timeframe, the 200-SMA acts as a strong resistance, near 0.7800, which also includes the 23.6% Fibonacci retracement level.

On the weekly timeframe, the price remains below the descending trend line, which started back in early-2013. In addition, the 50-SMA remains below both the 100-SMA and 200-SMA, while the price remains below the previous high of 0.7830. Moreover, the weekly technical indicators are moving near their mid-levels despite the recent pullback, while the daily ones turned bearish as they start moving south.  On the other side of the coin, a clearance of the 200-month SMA, the descending trendline and the 23.6 Fibonacci retracement level, at 0.78000, would be a good first step to changing the direction of the trend, prompting a move back towards 0.8600. But a failure to maintain the move higher would see the price move further down and test the significant level at 0.6800.

So, our bearish key target for now is the psychological level of 0.6800. On the downside, we will pay close attention to 0.6800. If and when the pair breaks below this level, we could easily see a sharp move towards the next psychological level at 0.6000. Therefore, our best case scenario is that the Australian dollar could continue to depreciate against the U.S. dollar in the longer term.

fig 6 AUD, Bulls, Back, Command, For How Long,, Currency Analysis, fx trader, forex

Figure 5. AUD/USD monthly, Source: JFD Brokers

Conclusion and Forecast

In my opinion, the Australian dollar is vulnerable to deeper losses for the remainder of the year. The Australian economy is performing reasonably well given current circumstances, but a sustained pickup in growth is not anticipated for some time. Moreover, a number of downside risks for the Australian economy have not eased. We are assured that the drop in commodity prices has not hit a bottom yet, while China’s slowdown, which weighs on global growth, particular in commodity dependent countries such as Australia and Canada, has not ended. Finally, the Federal Reserve is expected to raise interest rates in the remainder of this year, most likely in its December meeting, which would provide support to the U.S. dollar and weigh negative on the Australian dollar.

I would continue to expect the AUD/USD pair to sustain below the psychological level at 0.8000 for the remainder of the year. That said, I believe the AUD will test its 7-year low, around 0.6800, in the coming months. For the long-term, I expect the Australian dollar to reach the ultimate zone of 0.5800 – 0.6000 which will signal a strong buy.

Efthivoulos Grigoriou
Head of Global Research and Analysis
JFD Brokers