RBA to cut tomorrow - MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that the Australian dollar is one of those currencies that is currently much stronger than what is implied by the 2-year swap yield spread with the US.

Key Quotes

“That spread in favour of Australia has shrunk notably in recent weeks as market participants price for the RBA cutting rates at its meeting tomorrow. The spread fell to a new low in July, dropping 30bps during the month before rebounding modestly toward the end of last week.

Given the FX price action and the failure to weaken in response to the shift in spreads in favour of the US dollar, the RBA may feel compelled to act tomorrow in order to forestall another advance. During June, when the 2-year spread was at a similar level, AUD/USD was trading at around 0.7200.

A few factors help explain the resilience of the Australian dollar. Firstly, as cited above, the dollar generally may now be reflecting some degree of political risk premium ahead of the US presidential elections. Secondly, iron ore prices have advanced further with optimism over the outlook for China helping. The closing price in July was 23% higher than the most recent low point in early June.

The 3mth OIS price implies a 75% probability of a 25bp cut over that period and given the risk of an AUD/USD overshoot is perhaps rising and given the scale of cut to inflation forecasts by the RBA in its May Statement on Monetary Policy, we believe an easing is likely, although the decision is finely balanced. We might not get a big FX reaction over the short-term given a cut is more priced than not.”