Australia Q1 CPI trading playbook
Posted on: 23 April 2019 , by: Chris Weston , category: Market Review
With an ever-increasing debate around whether the RBA will cut interest rates, not just in 2019 but even as soon as Q219, a weak inflation print this Wednesday (at 11:30 AEST) could give the Reserve Bank increased ammunition and need to stimulate.
Granted, the RBA has expressed that deterioration in employment trends is its dominant consideration for guiding the cash rate lower, but inflation is certainly a close second. Therefore, further evidence of disinflation and a more troublesome path for price pressures will, at the minimum, need to be partly offset by a lower AUD and that will likely come in a far more definitive signal in the bank's communication that rate cuts are coming.
As expected, last week’s March employment print rose marginally to 5%. However, it offered few new insights for the RBA into the “tensions” between a tight labour market and weak employment trends. It seems logical, then, that the Q1 inflation read takes on increased significance and as a key consideration for the RBA, it should be for AUD traders too.
Of course, we also have to consider if this inflation print isn’t as materially weak as some are expecting. Notably, after some market participants, perhaps incorrectly, felt last week’s weak New Zealand CPI print of 0.1% QoQ is indicative that Australia’s inflation rate may follow suit. One should consider then, how a less bad inflation print affects not just a market already short of AUD’s (source: CFTC data), but one also already positioned for rate cuts through this year. Therefore, a trimmed mean quarterly inflation print of 0.5%, or indeed above, will have traders questioning if the 18 basis points (bp) of cuts priced by August are too pessimistic, which, in turn, should support the AUD.
As with any key economic release, it’s the magnitude of the beat/miss that will influence expectations of future central bank policy changes and pose potential duress to portfolios. Therefore, by way of managing risk, reducing position size and interest rate sensitive exposures into the inflation print is prudent. That said, the post-CPI release playbook could have longer lasting effects on the AUD, and offer new opportunity. As is often the case in trading, reacting above prophesying.
I have used the quarter-on-quarter (QoQ) trimmed mean inflation print as my guide.
Trimmed mean CPI of 0.3% or below – This would take the year-on-year pace to 1.6% and 15bp below the RBA’s forecasts of 1.75% yoy. This also opens the possibility that headline inflation could actually fall (QoQ) in Q1, and that may get the lion’s share of headlines. In this scenario, the implied probability of a June rate cut increases from 18% to around 35%. AUDUSD tests 0.7081 (the 61.8% fibo of the March to April rally). The ASX 200 should rally towards 6350.
Trimmed mean CPI of 0.5% or above – The implied probability of a rate cut in the June RBA meeting decrease from 18% to 5%, with a more aggressive re-pricing of August and September rate cut expectations. AUDUSD should close above the 200-day moving average at 0.7185, with a possible test of the 17 April high. AUDNZD longs would be preferred here, on the continued idea of central bank divergence with the RBNZ.
Trimmed mean CPI of 0.4% – This takes the year-on-year pace of core inflation to 1.7% and in-line with the RBA’s own forecasts. With the RBA feeling unemployment remains at 5% until June 2020, and inflation running to forecast, this inflation print offers few new clues. It would validate the low implied volatility in AUDUSD and the expected move through the Wednesday expiry of 32-points.
Positioning and sentiment – We head into the CPI release with both hedge funds and asset managers short of AUDUSD, but not at extremes.
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