The RBA playbook

We head into tomorrow’s Reserve Bank of Australia meeting delicately poised for further easing from the Australian central bank. 

RBA
Source: Bloomberg

For traders looking at trading opportunities around the meeting, it is important to understand the current variables in play. This could help shape directional bias on various assets, or at least help as part of one’s risk management.

Market expectations

As things stand, the interbank market is pricing the probability of a further 25 basis point cut at 50%. The economist community are a touch more optimistic, with 18 of the 29 surveyed by Bloomberg calling for easing.

Options markets aren’t overly concerned, with overnight implied volatility currently at 10.44%, below the average of the last month of 14.4%.

If we look at the weekly Commitment of Traders (CoT) report, we can see speculative funds hold a net short position of 63,000 contracts – the highest level since February 2014. So from a pure risk to reward perspective, if we don’t see the RBA cut, there may well be a bigger upside reaction than if it does cut.

Market moves

Since the last RBA meeting, the trade-weighted AUD has gained 0.3%, although it has found better sellers against the NZD and GBP. AUD/USD was around $0.7800 just prior to the 25 basis point cut, so the actions have failed to really push the unit lower. Interestingly, there is a strong correlation with high grade copper of late, which in turn has found good buyers.

Importantly, the spread between the Australian two-year bond and the US two-year treasury has declined to 1.17% - the lowest since late 2010. As this premium (or spread) declines, so too does the desire to hold AUD. I would suspect that if the RBA does cut and opens the door to a more implicit easing bias, this spread will decline to 1.10%, in turn lowering the pair towards the recent low of $0.7626.

While there have been limited moves in the currency market, this is not the case in the equity market, with the ASX 200 gaining over 5% since the 3 February cut. Banks have been the backbone behind the move, helped by improved net interest margins from a bigger cut to term deposits.

The case for a cut

It seems a pure question of ‘when’, not ‘if’ now. With this in mind, if the RBA doesn’t cut tomorrow, then May would almost certainly see easing of the cash rate and the markets are fully discounting this. Those calling for a cut would say the RBA often moves in pairs, and as Glenn Steven’s said in last week’s parliamentary testimony:  ‘if you feel the case has emerged and it is clear enough, it is usually best to get going on it.’

We have seen a benign outlook in last week’s non-mining capex intentions for businesses, while wages data and the inflation outlook in the recent Statement on Monetary Policy also gave the bank reason to ease. The RBA minutes have also looked at ways that APRA can rein in the property market, which will naturally benefit from the cash rate pushing to 2% and even below. Recent auction statistics suggest investors are warming to the cuts, so macro prudential tools could be more forcibly used in a bid to limit the upside.

The RBA still believes the AUD is above most levels of fundamental value, and Glenn Steven’s own view is that AUD/USD should be closer to $0.7500. So the central bank needs to keep the pressure on, especially with most other central banks easing conventionally, or unconventionally (quantitative easing).

Conclusion

There is a view that the RBA will wait until the 22 April inflation data to ease again, with the February cut looking like an insurance cut. Certainly the recent statement didn’t give a clear indication that a further cut was on the cards, but then there is new data which has changed the argument somewhat. Still, the run of data suggests easing will materialise, so the question traders need to ask is why wait until May?

So I am going for a cut tomorrow after taking all of this into consideration, although this is a close call. One could potentially look at playing AUD/USD from the short side, with a stop loss above the upper band of the September channel around $0.7920. A break of the 20-day moving average at $0.7795 would open a move to the lower Bollinger band at $0.7724.

AUD/NZD also looks vulnerable and a break of the recent low of NZ$1.0301 opens a move to the parity level. Long GBP/AUD positions have also been a market favourite of late and a move back to the 2 handle seems likely in the short-term.

AUD/USD chart

AUD/USD chart
Source: IG charts

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