AUD/USD: Trading the Reserve Bank of Australia Interest Rate Decision

Trading the News: Reserve Bank of Australia Interest Rate Decision

What’s Expected
Time of release:        12/01/2009 03:30 GMT, 22:30 EST
Primary Pair Impact :    AUDUSD
Expected:         3.75%
Previous:         3.50%

Impact the RBA interest rate decision has had on AUDUSD over the last 2 meetings

November 2009 RBA Interest Rate Decision

The central bank in Australia increased the benchmark interest rate for the second consecutive month in November by 25bp to 3.50% however, the Reserve Bank of Australia went onto say that the pace of rate hikes remains an “open question” as policy makers weigh the prospects for a sustainable recovery. RBA Governor Glenn Stevens said that that the marked appreciation in the Australian dollar “is likely to constrain output in the tradeables sector and dampen price pressures” going forward as the exchange rate continues to push towards parity, and went onto say monetary policy will be “gradually” normalized as the outlook for global growth remains weak. At the same time, the central bank stated that price growth remains “consistent with the target over the years ahead,” but argued that the recovery “could prove fragile” in the months ahead as the economic stimulus begins to taper off.

October 2009 RBA Interest Rate Decision

The Reserve Bank of Australia unexpectedly raised the cash rate by 25bp to 3.25% in October as the $1T economy skirts the global recession and expands throughout the first-half of the year. The RBA minutes said that the “very expansionary setting of policy was no longer necessary, and possibly imprudent” as the outlook for growth and inflation improves, with the board turning increasingly hawkish as policy makers saw the “expected trough in inflation was significantly higher than earlier thought.” At the same time, the central bank argued the marked appreciation in the exchange rate could “help to contain inflation,” and held an improved outlook for the economy as policy makers no longer see a “risk of serious economic contraction” going forward. As a result, investors speculate the RBA to tighten policy throughout the second half of the year, and expectations for higher borrowing costs may drive the Aussie higher as market sentiment improves.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the AUD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on AUDUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the AUD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on AUDUSD ahead of the data release.

How To Trade This Event Risk

The Reserve Bank of Australia is widely anticipated to raise the benchmark interest rate by another 25bp in December to 3.75% as the $1T economy skirts the global recession, and expectations for higher borrowing costs may continue to drive the exchange rate towards parity as investors speculate the central bank to tighten policy throughout the first-half of 2010. A Bloomberg News survey shows 19 of the 21 economists polled forecast the central bank to hike the benchmark interest rate by a quarter percentage point to 3.75%, while investors see a 60% change for a 25bp rate hike according to Credit Suisse overnight index swaps, and policy makers may continue to normalize policy going into the following year as the outlook for growth and inflation improves. A report by the Australian Bureau of Statistics showed the economy unexpectedly added jobs for the second consecutive month in October as business confidence rose to its highest level in nearly six-years, and firms may continue to ramp up production and employment throughout the remainder of the year as China, Australia’s biggest trading partner, leads the global recovery. Moreover, consumer inflation expectations grew at an annualized pace of 3.2% in November to hold above the RBA’s target range, with the headline reading for inflation increasing 1.3% in the third quarter, and prospects for higher consumer prices could lead the RBA to hold a hawkish outlook for future policy as the central bank maintains its dual mandate to ensure price stability while fostering full-employment. However, a separate report showed business investments unexpectedly tumbled 3.9% in the third-quarter, with operating profits falling 2.1% during the same period after sliding 7.0% during the three-months through June, and the general weakness in the overall economy may lead the central bank to hold a neutral policy going forward as the marked appreciation in the exchange rate continues to “constrain output and dampen inflationary pressure.” The RBA minutes said that the outlook for future policy “remained an open question” as “business and consumer confidence could prove fragile, and economic activity at home and abroad might slow more than expected as the effects of stimulus measures faded,” and the cautious outlook held by the board could lead the RBA to keep rates on hold in December as policy makers weigh the prospects for a sustainable recovery. However, RBA Deputy Governor Ric Battellino held an improved outlook for the region and said that the nation has initiated a “new upswing” as the region skirts the global recession, and anticipates the rise in growth to last for a “few more years” as the expansion in monetary and fiscal policy continues to support the real economy. As board members expect the economy to expand going forward, the central bank may tighten policy in December as the region continues to benefit from the economic expansion in China, and expectations for higher borrowing costs is likely to support the rally in the Australian dollar as the RBA remains the only major central bank to normalize monetary policy this year. 

Expectations for a 25bp rate hike favors a bullish outlook for the Australian dollar, and price action following the rate decision could set the stage for a long aussie-dollar trade as policy makers ramp up expectations for future growth. Therefore, if the RBA hikes the benchmark interest rate by 25bp to 3.75% this month and holds a hawkish outlook for future policy, we will look for a green, five-minute candle subsequent to the policy meeting to confirm a buy entry on two-lots of AUD/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance taking volatility into account, and this risk will establish our first target. Our second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to preserve our profits.

In contrast, the marked appreciation in the exchange rate paired with fears of a protracted recovery may lead the RBA to adopt a wait-and-see approach in December, and the central bank may keep rates on hold in the first-quarter of 2010 as the government stimulus begins to taper off. As a result, if the central bank holds the cash rate at 3.50% and maintains a neutral outlook for future policy, we will favor a bearish outlook for the Australian dollar, and will follow the same setup for a short aussie-dollar trade as the long position mentioned above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com