AUD/USD May Take On 0.8600 On RBA Rate Hike To 6.50%

[B]AUG 7 RBA Cash Target (14:15 EST; 18:15 GMT)
Expected: 6.50%
Previous: 6.25%[/B]

[B]How Will The Markets React?[/B]
The Reserve Bank of Australia is widely expected to raise their cash target by 25 basis points to a nearly 11-year high of 6.50 percent, as consumer prices in the second quarter proved to be stronger-than-expected while retail sales were surprisingly resilient. While Australian government bond yields have climbed ahead of the anticipated rate hike, reactions by fixed income, forex, and equity markets will depend more upon the RBA?s policy statement, as the bank could move to a more neutral stance. Despite the fact that consumer price growth was higher than estimates, the figure still eased back to 2.1 percent from 2.4 percent, which is within the RBA?s 2-3 percent target band. Furthermore, the official jobless rate ticked higher in June, rising to 4.3 percent from a record low of 4.2 percent, signaling that the tightening of the labor market that has been fueling consumption may be nearing an end. As a result, rate hike expectations for the future could be diminished, leading Australian markets to ignore the policy tightening action at hand. On the flip side, bond yields and the Australian dollar could surge if RBA Governor Glenn Stevens maintains a hawkish stance.
[B]Bonds - 10-Year Australian Government Bond Futures[/B]
Intraday charts showed the 10-year Australian government bond futures easing back from resistance at 94.10 ahead of the RBA decision, as the contracts hold just above support at 94.00. A rate hike instituted by a central bank typically results in higher yields for government bonds, however, if the RBA signals a neutral stance in their policy statement, prices could actually resume their ascent. On the other hand, if the central bank indicates that they are still concerned about upside inflation risks, Australian government bond futures could drop towards short-term trendline support near 93.95.

[B]10-Year Australian Government Bond Futures (Intraday Chart)

Over the past few days, AUD/USD has consolidated into a narrow range, setting the stage for a possible breakout upon the RBA?s rate decision. While a rate hike will likely send the pair spiking higher to test 0.8600, the pair could subsequently back off if the policy statement issued at the same time signals a more neutral stance for the central bank. If forex traders perceive that RBA Governor Stevens is not staunchly hawkish, AUD/USD could actually plunge towards the August 1st lows near 0.8450 after rallying on the rate hike news. On the other hand, if the RBA appears to be looking towards additional policy tightening in the near-term, any AUD/USD gains achieved will only be exacerbated, as carry trade differentials would continue to work in favor for the pair. The final scenario is if we see that the RBA surprisingly leaves rates steady, as the news would have particularly bearish implications for the Australian dollar in general given the widespread expectations for a 25 basis point increase.
[B]AUD/USD (Intraday Chart)

[B]Equities - ASX 200 Index[/B]
The risk aversion-led plummet of the S&P/ASX 200 to the 6,000 level was stopped short at 200 SMA support at 5,924, where price has consolidated for the past four days. The equity index?s next move will likely be determined by the RBA?s rate decision, as a hike would typically trigger a sell-off, but if the central bank issues a neutral policy statement, the S&P/ASX 200 could actually climb towards the 6,100 level. On the other hand, if the RBA remains concerned about upside inflation risks, the index could take out 5,900 once and for all, especially if other Asian equity markets take a hit during the session.
[B]ASX 200 Index (Daily Chart)

[B]Written by Terri Belkas, Currency Analyst[/B]