WESTPAC: We can't be too bearish on the Australian dollar right now

Getty / John Moore

Less than 24 hours away from the Reserve Bank of Australia’s (RBA) August monetary policy decision, at which the bank is broadly expected to cut interest rates to a fresh record-low of just 1.50%, the Australian dollar couldn’t care less.

At 76 cents, the AUD/USD currently sits at the highest level seen since mid-July, seemingly unperturbed about the prospect of an interest rate cut tomorrow.

AUD/USD Daily Chart

And who can blame those buying the Aussie at these levels for doing so? Whether tomorrow or in the months ahead, financial markets expect not only one, but potentially two, rate cuts from the RBA.

Further easing is fully priced in. Baked in the cake. Locked in.

This suggests that other factors, aside from the outlook for Australian interest rates, are underpinning the Aussie dollar at present.

According to Sean Callow, senior currency strategist at Westpac, there’s a good reason for the resilience of the Aussie , pointing out that commodity prices key to Australia continue to firm while expectations for rate hikes in the US are going in the other direction.

Here’s Callow on why he “can’t be too bearish right now” on the Aussie right now, even with the prospect of lower domestic interest rates.

Australia’s commodity price basket is at highs dating to May 2014, while emerging markets Asian equities have seen heavy foreign demand this month, as Brexit impact is seen as largely contained to Europe. The FOMC statement (last) week also lacked the urgency to raise rates that could have fuelled fresh USD/majors gains. Yield spreads should still chip away at AUD/USD multi-month but the damage should be limited near term.

Given another rate cut from the RBA is expected, either tomorrow or at a later date, Callow suggests that a 25 basis point reduction from the RBA in August — if delivered — will only deliver a “flesh wound” to the Aussie, rather than a knockout punch to drive it significantly lower.

“A rate cut is fully priced by November but is a wary 60% or so for (August). This sets up AUD/USD for a volatile day,” says Callow. “Clearly our baseline scenario of a rate cut should at least knock AUD lower initially, towards 0.74.”

While Callow suggests that any reduction in the cash rate will likely have a negligible impact on the Aussie, representing a decline of around 3% from its present trading level, the question many are now asking is where the AUD/USD will head should the RBA refrain from cutting rates?

Given heightened expectations surrounding further easing, not only from markets but also the economic community, it’s likely to be a massive move higher should the cash rate remain at 1.75%.

Many will be eyeing the recent peak of .7675 struck in mid-July, and beyond that the 2016 high of .7835 seen on April 21.

Mirroring the sentiment expressed by Callow, James McIntyre, an analyst at Macquarie Research, wrote in mid-July that more rate cuts from the RBA will merely prevent the Australian dollar from rising further, rather than helping to weaken it.

“We remain of the view that the RBA will need to cut rates further, dragged down by a disinflationary outlook,” said McIntyre. “But with easing elsewhere, those rate cuts are unlikely to deliver significant A$ weakness. Rather, rate cuts are now likely to be needed to contain A$ upside,” he said.

“Although the RBA is cutting, we don’t think it will be cutting fast, or far, enough.”

Whatever decision the RBA board makes tomorrow, it certainly won’t be easy, or without its risks.

Do they cut and risk stoking further heat in the property market, or leave rates unchanged and watch the Aussie dollar soar, something that along with heightened levels of labour market slack will do little to help lift the outlook for inflation?

Come 2.30pm AEST on Tuesday, it’s going to be a wild time for Australian financial markets, one way or another.

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