AUDUSD battered on dovish RBA, risk aversion

Let’s start with the speculation of more RBA easing. Deputy Governor Guy Debelle virtually addressed The Australian Industry Group on Tuesday with a speech titled “The Australian economy and monetary policy.” Debelle outlined the bank’s policy response to this year’s economic fallout, accompanied by a list of further easing tools that may be necessary in the ongoing recovery. Importantly, he reiterated that fiscal policy is having the largest impact in the recovery - a sentiment that has been echoed by central banks across the world.

The RBA pretty quickly tapered its QE program earlier this year when credit conditions eased and the bond market started performing normally, and data indicated the economic fallout wasn’t as bad as expected.

But it looks like more easing is once again on the table. The RBA’s labour market and inflation outlook is out of sync with its objectives, so Debelle outlined a list of policy options that could help achieve targets sooner. The options include purchasing government bonds further out the curve, foreign exchange intervention, another cash rate cut and even the prospect of negative interest rates.

Debelle acknowledged the shortcomings of FX intervention and negative rates. On FX intervention, he noted it may have little effect if the currency is trading close to its “fair value”. Citing higher iron ore prices, a relatively strong recovery, and USD dynamics, RBA modelling suggests the AUD isn’t too out of line with a fair valuation.

Importantly though, all of Debelle’s options would be AUD-negative, and we’ve seen markets price this in as AUDUSD has consistently fallen this week. The forex pair opened the week at 0.7280, sinking to as low as 0.7016 yesterday and 0.7043 on Friday’s open. Start trading forex today.

Sinking beneath the 50-day EMA (purple) on Tuesday encouraged the bears, and was followed by a huge daily drop Wednesday. From here, the 0.7000 handle is a huge level but price has so far shied away from testing it. Price has been comfortably above 70 US cents since mid-July, and a move south of here would be a big shift in dynamic.

Daily chart: AUDUSD. Chart source data: Metaquotes MT5.

The question now is has the AUD correction bottomed out for now? Markets expect more RBA easing in October or November in the form of either more QE or a rate cut - or both. The current cash rate target is 0.25% but due to accommodative liquidity the traded rate is closer to 13-14bp. A cut to 0.10% seems a likely outcome.

Whatever the upcoming RBA meetings bring, AUDUSD price action would suggest further easing has been accounted for. What’s certain is that Debelle’s comments have helped take a little pressure off the accelerating AUD, which was on track to cause the bank some serious headaches.

But there’s more at play than simply a dovish RBA surprise here. The Australian dollar is a high-beta currency and a global risk proxy, so it’s extremely sensitive to shifting global risk sentiment. What we’ve seen this week is a sell-off in US stocks as COVID cases spike again, the Fed’s Powell indicates a long road ahead to economic recovery, and traders reconsider exposure as increasing uncertainty around the US election sets in. The risk aversion has caused a flight to safety in the US dollar, and the AUD has suffered.

What started as a rotation out of very expensive tech stocks early September has had a contagion effect across broader US stocks. Small and mid cap companies have suffered too and we see this on the Russell 2000 index (US2000), which has been offered lower in a descending channel. Price closed below the 200MA (black line) on Tuesday, often a bearish sign for equity markets, but futures in the early Friday session suggest the bulls will defend the level. If they fail to defend it, the risk-off mood may have more havoc to cause yet and could spill over to the AUD. One to watch.

Daily chart: Russell 2000 (US2000).

We’ve also seen the MACD oscillator (bottom pane) revealing a lower high for the September highs than those of August. This is known as bearish divergence, signalling a weakening trend and possible move lower.

US stocks have been battered this week as traders go risk-off, assessing poor fundamentals and hedging election risk. In fact, if we consider benchmark US index the S&P 500 (US500), we find price often moves in the same direction as the AUD. As risk aversion drives US stocks lower, the USD receives a bid as traders seek safety in the world’s reserve currency. When also considering the RBA’s dovish surprise, the AUD has suffered a double blow this week. While Debelle’s dovish comments look to be priced in, the outlook for the AUD now hangs on global risk sentiment.