NAB: The Australian dollar could soar if the RBA doesn't cut rates next week

Photo: Oleg Nikishin/Getty Images

While recent out-of-cycle rate hikes from Australia’s largest banks have seen expectations for further rate cuts from the RBA grow – pushing the odds for a 25 basis point cut in November to around 30% – most in the markets believe that the RBA will resist the urge to cut the cash rate to a new record low level of 1.75% when it meets on November 3.

According to the NAB’s FX strategy team, with the RBA unlikely to cut interest rates at this meeting, there are growing risks that the Australian dollar could push significantly higher in the weeks ahead, fuelled in part by continued short covering, higher interest rate differentials and lower financial market volatility.

Here’s the NAB on what they believe could act as the potential catalyst to drive the AUD/USD above .7382, the recent high struck on October 12.

“It’s highly doubtful that the past fortnight’s AUD/USD range will hold post RBA. A cut, which will certainly surprise us and most of the market, brings 0.70 back into play. NAB’s views is that the RBA will at least want evidence the economy may be spluttering, whether or not as a result of these out-of-cycle rate rises. On inaction, then in the context of latest ECB signals and diminishing perceived risk of Fed 2015 lift-off, AUD is susceptible to gains. This is likely both from renewed short covering and likely revival of interest in being long AUD assets as a carry trade amid declining market volatility. The VIX, for example, has more than halved since early September, from above 30 to below 15.”

Based on its own internal modelling, the NAB believes that the fair value for the Australian dollar is now “just shy of 80 cents”, a significantly higher level than the .7240 level it currently trades at today. The chart below, supplied by NAB, shows the current fair value for the AUD/USD based on its modeling compared to the current spot price shown in red.

While the NAB’s view is consistent with the majority in financial markets, other banks – particularly investment banks – believe that the recent out-of-cycle rate hikes from the CBA, Westpac, ANZ and NAB, along with the subdued growth outlook for the Australian economy in the months ahead, will likely see the RBA cut interest rates next week.

Goldman Sachs and Morgan Stanley predict that the RBA will cut the cash rate to 1.50% by the end of the March quarter next year, while Macquarie Bank believes that the risk for two rate cuts, rather than the one they currently foresee, is growing. UBS, like Macquarie, also forecast a 25 basis point rate cut from the RBA, suggesting two weeks ago that a November rate cut would be “the path of least regret”.

The RBA November meeting will follow a busy period for central banks with the US Federal Reserve, Reserve Bank of New Zealand (Thursday morning AEDT) and Bank of Japan (Friday afternoon AEDT) all scheduled to announce monetary policy decisions later this week. The ABS will also release September quarter Australian CPI at 11.30am AEDT Wednesday.

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