RBA 25bp Cut – Yes or No?

September has been a rocky month for the US dollar. The trade weighted Dollar Index climbed to its strongest level in nearly 2 years, but on a relative basis the dollar’s gains were limited to the Japanese Yen, New Zealand dollar, Swiss Franc and euro. Sterling, the Canadian and Australian dollars outperformed the greenback as position adjustments (short-covering) drove those currencies higher. There were two big developments for the US this month both of which should have been negative for the US dollar but instead of falling, the greenback strengthened as investors dismissed the forward impact of recent developments. To be more specific, while the Fed cut interest rates by 25bp in September, based on the way policymakers voted and their projections according to the dot plot, the September move may have been their last rate cut of the year. The House is leading an impeachment inquiry into President Trump but the chance of the Senate voting in favor of removing the President is less than 10%. At the same time, the Eurozone, Japanese and New Zealand economies are weakening further driving investors into the safety of US dollars.

Tonight, the Reserve Bank of Australia is expected to lower interest rates for the third time this year. The decision will be a close one. According to a poll of 32 economists by Bloomberg, 25 expect the central bank to ease and 7 expect no change. Last week, the Australian dollar rallied after RBA Governor Lowe said Australia’s economy has reached a gentle turning point. He is worried about household spending but expects a further modest GDP pickup in the quarters ahead. With that said, he also believes that the strength and durability of the pickup remains to be seen so they’ll “take stock of everything in October and decide if further easing is necessary.” Back in early September when they last met, the RBA said wages were moving upwards and the signs of a turnaround in the housing market should support spending. Since then, we’ve seen significantly deterioration in the economy with retail sales falling, labor market conditions weakening, inflation expectations dipping and business confidence souring. The slowdown in China’s economy deepened, hardening the case for further RBA easing.

If the RBA lowers interest rates tonight, we’ll see a knee jerk decline in AUD/USD but the durability of that decline will hinge upon their guidance. If the RBA emphasizes the improvements in the economy and their expectations for stronger GDP growth, AUD/USD could bottom quickly. If they leave rates unchanged, we’ll see an even stronger rally in the currency. The only situation where AUD/USD will fall to a fresh September lows would be if they cut and left the door wide open to more easing which is unlikely after 3 rounds of stimulus.

The New Zealand and Canadian dollars also weakened against the greenback today with NZD leading the slide on the back of weaker business confidence. EUR/USD dropped to fresh 2 year lows on reports that German growth forecasts could be lowered, raising the risk of further ECB easing. The Japanese Yen is under pressure because after two postponements, the Japanese government is expected to move ahead with a planned sales tax increase to 10% from 8% on Tuesday. The last increase in 2014 caused the economy to shrink 7% and the BoJ to expand stimulus. To avoid the same fate, the Abe administration rolled out a number of measures to ease the pain but in the context of slower global growth, the central bank may have no choice but to step in again.