RBA Policy, China Risks, and the Path Ahead
Monday, October 21, 2024 (Week 43)
Australia, a key player on the world stage, boasts a stable parliamentary democracy. Currently, the Labor Party, led by Prime Minister Anthony Albanese, governs with a centre-left political leaning. Strong alliances with Western democracies, particularly the US, along with its important economic ties with Asian nations, especially China, shape its foreign policy. As a robust economy and a major exporter of commodities like iron ore and coal, Australia maintains a significant global standing. Looking ahead, the RBA's upcoming interest rate decision on Tuesday, November 5th (Week 45), is a crucial event that will influence the country's monetary policy trajectory and the AUD's strength.
Throughout the past month (September 1 - October 21), the most influential market theme impacting the AUD, iron ore, and coal has been the RBA’s hawkish stance on interest rates, coupled with the ongoing economic slowdown in China. These intertwined forces have created significant uncertainty. The RBA has steadfastly held the cash rate at 4.35% since May to combat inflation, providing some support to the AUD (Trading Economics, October 21, 2024). This hawkish hold reflects the RBA’s concerns about persistent inflationary pressures, despite the monthly CPI easing to 2.7% in August (ABS, September 25, 2024). However, China's economic slowdown is weighing heavily on demand for Australian commodity exports, especially iron ore and coal, which negatively impacts the AUD (Trading Economics, September-October 2024). Weaker-than-anticipated economic data from China has fueled concerns among investors about a global economic slowdown, adding further downward pressure on commodity prices and thus the AUD.
Investment Thesis
Upcoming Week (October 21 - October 28): A bearish outlook for the AUD is warranted. The looming RBA interest rate decision on November 5th could reinforce the central bank's hawkish stance. Persistent concerns about China's economic health will likely continue to exert downward pressure on the AUD. Adding to the bearish sentiment, escalating geopolitical tensions in the Middle East could trigger a flight to safety, boosting the USD at the AUD's expense.
Upcoming Month (October 21 - November 30): The outlook for the AUD over the next month is neutral. The risks associated with China’s economic trajectory and a hawkish RBA persist. However, the upcoming Australian jobs report for October (due on November 14) has the potential to offer some relief if it signals continued strength in the labour market. Additionally, any signs of a more robust stimulus package from China could support commodity prices and, in turn, boost the AUD. Should inflation show further signs of cooling, it might temper the RBA’s hawkish stance, providing further support to the AUD.
Australian Financial Markets: Navigating Uncertainty Amidst Record Highs
Australia's financial markets, encompassing the AUD, the S&P/ASX 200 stock market, government bonds, and crucial commodity exports like iron ore and coal, face a complex landscape. A key event on the horizon is the RBA's interest rate decision scheduled for Tuesday, November 5th (Week 45), which will significantly influence the AUD's trajectory and investor sentiment.
ASX 200: Record Highs, but Underlying Risks Remain
The S&P/ASX 200 has reached successive record highs over the previous month (September 1 - October 21), fueled primarily by strong earnings in the banking and mining sectors. This performance, however, may not fully reflect the underlying economic realities. Weak Q2 GDP growth and a contraction in private capital expenditure raise concerns about the rally's sustainability. The strong performance of the stock market could potentially lend some support to the AUD, but the risk of a market correction remains, especially if the rally's dependence on external factors is challenged by unforeseen global events.
Bond Market: Yields Respond to RBA Hawkishness
Australian bond yields, especially the 10-year government bond yield, rose over the past month, reflecting the RBA’s hawkish stance and ongoing concerns about inflation (Trading Economics, October 21, 2024). RBA Governor Bullock’s comments on August 20th, emphasising upside inflation risks (RBA, August 20, 2024), contributed to the upward pressure on yields. This upward trend in yields aligns with the RBA’s efforts to control inflation and could, in the short term, lend support to the AUD. However, if the RBA continues its hawkish stance and raises rates further, concerns about the impact on economic growth could deepen, potentially leading to increased volatility in the bond market and impacting the AUD negatively.
Commodities: Iron Ore and Coal Navigate a Slowdown
Iron ore and coal, key Australian commodity exports, have been under pressure during the past month, due primarily to the ongoing economic slowdown in China, a major importer (Trading Economics, September-October 2024). The decline in iron ore prices has negatively impacted Australian mining companies listed on the ASX. Adding further volatility, geopolitical events, particularly the escalation of tensions in the Middle East, have created uncertainty about energy markets, influencing related commodity prices. This weaker commodity market has weighed on the AUD, demonstrating the close link between the currency’s value and commodity price movements. However, if China’s stimulus measures gain traction and boost demand, it could potentially trigger a recovery in commodity prices, which would be beneficial for the AUD.
Australian Economy: Balancing Act
Australia's economy relies heavily on its services sector, with mining and agriculture also contributing significantly. Key exports include iron ore, coal, and natural gas, while imports are primarily machinery, vehicles, and electronic equipment. Trade with China is crucial for Australia's economic health. The release of September quarter CPI data, scheduled for Wednesday, October 30th (Week 40), is the most significant upcoming economic event. This release will provide insights into the current inflationary environment and could influence the RBA's upcoming interest rate decision.
GDP: Soft Growth Raises Concerns
Australian GDP growth has been lacklustre, expanding by a mere 0.2% qoq in Q2 2024 (ABS, September 4, 2024), the slowest pace in five quarters and below forecasts. This sluggish growth reflects weakened domestic demand, particularly in household consumption, and decreased investment. The weak GDP data has weighed on the AUD, reinforcing concerns about the economic outlook. The current consensus forecast for Q3 2024 is 0.5% growth (Trading Economics, October 21, 2024). Achieving this forecast could provide a modicum of support to the AUD, but the continued risk of a technical recession remains a significant downside risk for the currency.
Inflation: Easing Trend Offers Hope
The previous month brought signs of cooling inflation in Australia. The monthly CPI indicator dropped to 2.7% in August (ABS, September 25, 2024), a three-year low and within the RBA’s 2–3% target range. Despite this positive trend, the RBA remains concerned about underlying inflationary pressures. The trimmed mean CPI, which excludes volatile components, remained at 3.9% in Q2 (ABS, September 25, 2024), indicating persistent inflation. This easing trend in inflation may eventually contribute to a less hawkish monetary policy. However, in the short term, the RBA's continued focus on fighting inflation could lend support to the AUD.
Labour Market: Mixed Signals
The Australian labour market presented mixed signals during the past month. While employment increased by a better-than-expected 64.1k in September (ABS, October 14, 2024), the unemployment rate held steady at 4.1% (ABS, October 14, 2024), above market expectations. This mixed data has had a muted impact on the AUD. The RBA's concerns about the tight labour market and its contribution to inflationary pressures remain. Therefore, the future trajectory of the unemployment rate will be crucial. An increase could signal easing labour market conditions, potentially weakening the AUD, while a decline would likely strengthen the currency.
Consumer and Business Sentiment: Tentative Optimism
Consumer and business sentiment in the past month presented a mixed picture. Consumer confidence improved in October, reaching a 2.5 year high of 89.8 (Westpac Banking Corporation, Melbourne Institute, October 14, 2024). However, business confidence remained in negative territory in September at -2 (NAB, October 12, 2024), although business conditions improved. This mixed bag of sentiment data reflects the broader uncertainty surrounding the Australian economy.
Upcoming Key Economic Data and Events
The following week (October 21st-28th) will see several key economic data releases for Australia:
RBA Hauser Speech (Monday, October 21): Forward guidance from the RBA could move the AUD.
Judo Bank Manufacturing PMI Flash (Wednesday, October 23): A continued contraction in manufacturing would likely weigh on the AUD.
Judo Bank Services PMI Flash (Wednesday, October 23): Strong services sector data would support the AUD.
Monthly CPI Indicator (Wednesday, October 30): This key inflation data will be closely watched by the RBA and could influence its next interest rate decision.
Australian Monetary Policy: Hawkish Stance Remains
Australia's central bank, the Reserve Bank of Australia (RBA), led by Governor Philip Lowe and Deputy Governor Michele Bullock, maintains its focus on price stability, with the primary objective of keeping inflation within its 2-3% target range. The RBA’s upcoming interest rate decision on Tuesday, November 5th (Week 45), will significantly influence market expectations and the AUD's trajectory.
RBA: Holding the Line Against Inflation
Over the previous month, the RBA has held firm in its hawkish stance, keeping the cash rate at 4.35% since May (RBA, September 25, 2024). Governor Lowe's repeated warnings about persistent upside inflation risks and the potential for further tightening if necessary (RBA, August 2024) underpin this stance. This contrasts with the current global trend of rate cuts. The RBA’s hawkish stance has provided support to the AUD. Market expectations for the RBA’s next move are divided. While some anticipate that the central bank will maintain its hawkish stance, others predict rate cuts in early 2025. A move towards easing would likely weaken the AUD, while continued tightening would strengthen it, especially against currencies of central banks adopting a more dovish approach. The release of the September quarter CPI data on Wednesday, October 30th (Week 40), will be crucial for assessing the inflation outlook and the RBA's likely course of action.
Australian Geopolitics: Regional Risks and Global Uncertainties
Navigating Political Headwinds
Australia’s political landscape, while generally stable, presents ongoing uncertainties. Strained relations with China and the looming federal election add to the complex mix of factors influencing the AUD. Trade disputes with China, Australia’s largest trading partner, continue to pose risks to the export-dependent economy. The upcoming election further clouds the outlook, as shifts in government policy could impact the market and the AUD. How these factors play out in the upcoming months will be key for the AUD’s trajectory.
Geopolitical Tensions Add to Uncertainty
Geopolitical risks, particularly the escalating conflict in the Middle East, and the ongoing trade war between the US and China, contribute significantly to the AUD's volatility. The potential disruption to global trade and energy markets, particularly if oil supplies are affected, could severely impact the Australian economy, weighing on the AUD. Any further escalation of these tensions could spark risk aversion, boosting safe-haven currencies at the AUD's expense.
Sovereign Risk: Stability Amidst Global Volatility
Australia's sovereign risk profile remains stable, supported by a strong sovereign credit rating and a healthy fiscal position, evidenced by the government's recent budget surplus. However, Australia is not immune to external factors. Its reliance on China for exports and its exposure to global commodity price volatility make the AUD vulnerable to shocks. Furthermore, domestic factors like high household debt levels and stagnant GDP growth warrant attention, as these could impact the AUD's strength in the longer term.
AUD Valuation: Navigating a Hawkish RBA and Global Uncertainty
Over the past month (September 1 - October 21), the AUD’s valuation has been influenced by the interplay between a hawkish RBA and a complex global economic landscape. While the RBA’s focus on taming inflation has provided some support to the AUD, the economic slowdown in China and concerns about a potential US recession have weighed on the currency, leading to fluctuations against the USD (Trading Economics, September-October 2024). The AUD traded near year-to-date highs of $0.68 earlier in the period but later depreciated slightly as China's economic outlook weakened.
Summary and Outlook
Australia faces a challenging economic environment, with a slowing global economy and a central bank determined to curb inflation. The RBA’s hawkish stance continues to be a key driver of the AUD’s value. In the upcoming week, the release of the RBA’s Financial Stability Review will be crucial for gauging the central bank’s outlook and its potential impact on the AUD. The release of retail sales data will also provide further clues about the state of the Australian economy. Geopolitical risks remain a major concern, with the potential to trigger a flight to safety and weaken the AUD.
Key Action Points for Forex Traders:
Monitor the RBA closely. Pay close attention to RBA communications for insights into the central bank's thinking.
Watch for developments in China. Monitor data releases from China, as these have a direct impact on commodity prices and the AUD.
Manage risk carefully. Given the current environment, implement appropriate risk management strategies, including stop-loss orders, to mitigate potential losses due to market volatility.
Risks and Uncertainties: The outlook for the AUD remains subject to several risks. A sharper-than-expected slowdown in China, further escalation of geopolitical tensions, or a more hawkish-than-anticipated RBA could weigh heavily on the currency. Conversely, a rebound in the Chinese economy, a de-escalation of geopolitical risks, or signs that inflation is easing faster than anticipated could strengthen the AUD.
Sources
Reserve Bank of Australia (RBA), Australian Bureau of Statistics (ABS), National Australia Bank (NAB), Westpac Banking Corporation, Melbourne Institute, S&P Global, Australian Industry Group, Judo Bank, Trading Economics.