RBA rate cut talk picks up, A$ slides

The Australian dollar has struggled this week, as a rise in Australia’s unemployment rate raised expectations of an RBA rate cut next month and the US dollar bounced despite the Fed’s rate cut.

The FOMC added support to US bond yields even as it cut the benchmark funds rate at consecutive meetings. The 25 basis point cut to 1.75-2.00% was very much expected but there was plenty for markets to absorb in the quarterly forecasts and Chair Powell’s press conference.

The economic forecasts were almost identical to June, with the 2019 GDP estimate actually nudged up to 2.2%. So the rate cut was premised on “the implications of global developments for the economic outlook as well as muted inflation pressures”.

This was the consensus view but the vote was unusually sharply divided, 7-3. The range of views among FOMC members is even more stark in the so called ‘dot plot’. Ahead of the meeting, 5 members preferred rates on hold into year end, another 5 (the median) see 1.75-2.00% by end-2019 and 7 more expect one more rate cut from here. But the median expectation for the Fed funds rate drifts a little higher from 2020 to 2021, not a very dovish outlook.

US-China trade tensions appear to be the main driver of the Fed’s dovish turn mid-year. So the early October trade talks in Washington loom large. Westpac continues to see 2 more rate cuts this year as we expect the protracted trade tensions to keep hurting business investment and then spill over to consumers.

As for the Aussie dollar, a week ago it made a run at 69 cents as US-China trade relations improved. But the 69 level didn’t give way and this week’s price action was discouraging. Resource company dividend conversions appear to be behind us and the attack on Saudi oil facilities ratcheted up tensions around the Middle East, leaving Asian equities and currencies skittish.

The most tangible blow to the Australian dollar however was the August labour force survey. Australia’s unemployment rate rose to a 12 month high of 5.3% despite still-robust jobs growth, especially part-time work. RBA Governor Lowe has said that we should be aiming for an unemployment rate more like 4.5%, so this report was a significant setback.

Pricing for the RBA to cut the cash rate to 0.75% on the 1st of October was only 25% a week ago but in the wake of the labour force data it is about 80% priced in. The Aussie fell under 68 cents as rate cut pricing picked up.

The global calendar is fairly low key in the week ahead, including speeches from ECB and Fed officials, a likely steady hand from the RBNZ and more Brexit drama. Australia’s focus will be the speech by RBA Governor Lowe in rural New South Wales. Unless he surprises by deliberately playing down rate cut expectations, the Aussie dollar is likely to remain under pressure.