The Reserve Bank of Australia is expected to raise interest rates by another 50 basis points when it concludes its meeting at 04:30 GMT Tuesday. Markets assign an 80% probability for such an action, so the aussie could enjoy some upside if the central bank executes. That said, any relief rally is unlikely to last long in an environment dominated by recession worries and cooling commodity prices.
Chugging along
The Australian economy is in pretty good shape. Unemployment is at a five-decade low, participation is at a record high with more people working than ever before, and consumers are swimming in savings they’ve accumulated over the last couple of years.
Of course inflation is very hot already and with the jobs market so tight, the Reserve Bank is worried that inflationary pressures could become a persistent phenomenon as workers demand higher wages. Hence, it has slammed on the brakes, raising interest rates with urgency to cool demand and prevent this wage-price spiral from materializing.
While the situation looks good domestically, the risks for the Australian economy come from abroad. Australia’s entire business model relies on exporting commodities like metals abroad, usually to China. With the Chinese property sector in deep trouble and worldwide concerns about a recession growing stronger, the growth outlook has started to turn darker.
Single or double?
The question for traders heading into this meeting is really the size of the rate increase – will the RBA stick to 50bps moves or will it get cold feet and deliver a smaller 25bps hike? Admittedly, the bigger move seems more sensible.
Risks surrounding economic growth might be on the rise but that hasn’t been reflected in the ‘hard’ data yet, which allows the central bank to keep going strong as it attempts to tame inflationary pressures. Since interest rates are still far below what policymakers consider ‘neutral’, the RBA would simply be removing stimulus, not choking the economy.
Market pricing currently suggests that a 25bps move is a done deal and there is an 80% chance for a 50bps hike. Thus, the aussie stands to gain if the central bank truly delivers a 50bps hike. In this case, aussie/dollar is likely to encounter initial resistance around the 0.6920 region.
FX market
In the bigger picture, what happens with monetary policy is secondary to how the global environment. Recession worries are currently in the driver’s seat, simultaneously putting pressure on risk sentiment and commodity prices, both harmful for the Australian dollar. In this kind of regime, any relief rallies in the aussie are likely to remain shallow.
There is also the risk that market pricing around the RBA has gone too far. The central bank is currently expected to raise rates at every single meeting until early next year, but if growth begins to stall, that may no longer be feasible.
Overall, it’s just difficult to be optimistic about the aussie in this climate and the charts tell the same story, with aussie/dollar sinking to new post-pandemic lows lately. Further declines could see the pair challenge the 0.6850 zone initially.
Some positive catalyst is required to change this gloomy narrative, for example a ceasefire in Ukraine or China abandoning its harsh lockdown strategy – calming nerves around global growth. Until then, the trend remains negative.
