Australian Dollar Threatened by Fading Risk Appetite, Surprise Rate Cut

The Australian Dollar’s five-week winning streak may be soon undone as mounting evidence suggests the Reserve Bank of Australia could surprise with a 0.25% rate cut while risk appetite looks fragile as the effects of the G20 summit fade to reveal a world still mired in the worst recession since World War II.

[B]Fundamental Outlook for Australian Dollar: Bearish[/B]

The Reserve Bank of Australia’s interest rate announcement clearly tops the economic calendar in the week ahead. Economists expect policymakers to keep rates unchanged at 3.25%, following Governor Glenn Stevens’ logic arguing that the cumulative effects of monetary and fiscal measures already in place will “provide significant support to domestic demand over the period ahead”. The market consensus seems to favor a different outcome, with overnight index swaps pricing in a 0.25% reduction this time around and between 50-75 basis points in total easing over the next 12 months. Early signals coming out of the central bank itself appear to hint at a dovish bias, with Assistant Governor Ric Battellino noting that annual output is “likely to fall in 2009”. This coupled with Steven’s comments in late March arguing that lower benchmark rates remained an effective way to stimulate lending (thereby separating the RBA from those banks that have opted to go down the path of quantitative easing) suggest that a rate cut is not out of the question. A surprise reduction may undermine the Australian Dollar’s allure after the high-yielding currency put in an impressive 5-week winning streak, adding 12% against its US counterpart on the back of a broad rebound in risky assets. Dour labor market data could compound bearish momentum, with expectations calling for the economy to shed 25k jobs through March to bring the unemployment rate to a 4-year high of 5.4%.

Looking beyond economic data, the Australian Dollar will face added downward pressure if the market’s recent taste for risky assets should be reversed. As we had mentioned some weeks ago, there are substantial reasons to believe that the current rebound in risk appetite is temporary: the dismal outlook for global economic growth in 2009 bodes ill for demand and will almost certainly be reflected in poor earnings reports, renewing downward pressure on stock exchanges. The initially supportive effects of the G20 summit in London may quickly fade as a detailed look at the final communiqué reveals policymakers actually offered little substance, reveling in lofty promises but committing to a relatively few tangible actions to deal with deepening global economic turmoil. Technically, the recent rally has taken the MSCI World Stock index within arms reach of the upper boundary of a falling channel that has confined prices since mid-October, bolstering the argument that the current upswing is corrective and suggesting that formidable resistance is to emerge in the near term.