MUFG: The AUD - FJElite
The Australian dollar was roughly stable yesterday with different crosscurrents keeping the FX moves limited. From an energy perspective, natural gas prices fell between 3- 4% in Europe and that from a terms of trade perspective is negative for AUD given Australia is the second largest global exporter of LNG. In addition, the escalation of tensions between China and the US carry risks for Australia and any deterioration in China growth expectations on a breakdown in the trade truce between China and the US would weigh on AUD.
But the minutes from the August RBA meeting were also released yesterday and the contents certainly point to the RBA being closer to a rate hike than currently implied by market pricing. Our current view is that the RBA can hold off from hiking this year. A full rate hike in Australia is not priced until Feb 2027 but the minutes from the August RBA meeting suggests the risk of another hike sooner are higher. "Several members" judged that it was “quite possible" that inflation risks would be realised and require further monetary tightening. A pre-emptive rate hike was considered at the meeting given these views. That would have been a considerable surprise given pricing the day before the meeting on 11,h August indicated zero probability of a rate hike. It suggests a tendency of the market to underprice RBA rate hike risks.
Today the monthly CPI data was released, and the data has reinforced the view that the RBA could prove more active than was priced in the market. The July CPI showed smaller than expected moderation with the annual CPI rate slowing from 3.8% to 3.5%, versus an expected 3.3%. Fuel costs increased but this was offset by an easing in household electricity bills - the fuel cost jumped relates to the unwinding of substantial fuel-tax rebates. The focus of the RBA is likely to be on the trimmed mean YoY rate which failed to slow as was expected, remaining unchanged at 3.6%. The data suggests RBA inflation concerns will continue.
That points to AUD continuing to perform well in current market conditions. However, the risks are starting to shift we are mindful of AUD starting to look stretched. The AUD/USD rate is starting to look over-extended relative to the 2-year AU-US swap spread. That can continue, but any disruption to risk that results in a spike in FX vol would likely see AUD suffer more than most.
