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:        02/02/2010 03:30 GMT, 22:30 EST
Primary Pair Impact :    AUDUSD
Expected:         4.00%
Previous:         3.75%

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

December 2009 RBA Interest Rate Decision

The Reserve Bank of Australia hiked borrowing costs by 25bp in December for a record third consecutive meeting, which pushed the benchmark interest rate to 3.75% from 3.50% in the previous month. Meanwhile Governor Glenn Stevens said that the “material adjustments” to monetary policy should keep inflation within the 2%-3% target range, and expects economic activity in 2010 “to be close to tend” as the economy skirts the global recession. As the central bank holds an improved outlook for future growth and aims to normalize policy this year, the RBA may continue to hike borrowing costs in order to balance the risks for growth and inflation. However, as global interest rates remain below pre-crisis levels, we may see the board hold a neutral policy stance going forward as the recovery in the world economy remains fragile.

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.

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 expected to tighten policy for an unprecedented fourth consecutive meeting in February, with market participants projecting the benchmark interest rate to rise to 4.00% from 3.75% in December, and the nation’s currency is likely to face increased volatility following the rate decision as investors weigh the outlook for future policy. A Bloomberg News survey shows all of the 20 economists polled forecast the central bank to raise borrowing costs by 25bp this month, while investors are pricing a 71% chance for a rate hike according to Credit Suisse overnight index swaps, and a rise in borrowing costs could drive the exchange rate higher as policy makers hold an improved outlook for growth and inflation. Nevertheless, consumer prices grew at an annualized pace of 2.1% in the fourth-quarter, which exceeded expectations for a rise to 2.0%, while the unemployment rate unexpectedly slipped to 5.5% in December from a revised 5.6% in the previous month, and conditions are likely to improve going forward as the expansion in monetary and fiscal stimulus continues to feed through the real economy. However, policy makers in China, Australia’s biggest trading partner, have signaled that they will take steps this year to temper the expansion in the region to prevent the economy from overheating, and we may see the RBA maintain a neutral policy stance going forward as global interest rates remain below pre-crisis levels. At the same time, home loans tumbled 5.6% in November to mark the biggest decline in 18-months, while consumer inflation expectations slipped to 3.5% from 3.6% in January, and the RBA may adopt a wait-and-see approach this month as households continue to face tightening credit conditions and adjust to rising borrowing costs.

Trading the given event risk favors a bullish outlook for the Australian dollar as market participants anticipate the RBA to raise the cash rate to 4.00%, and price action following the rate decision could set the stage for a long aussie trade as the central bank holds an improved outlook for the $1T economy. Therefore, if policy makers opt for a 25bp rate hike and hold a hawkish outlook for future policy, we will need to a see a green, five-minute candle following the announcement to generate 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 an effort to preserve our profits.

In contrast, the pull back in the housing market paired with the weakness in the global recovery may lead the RBA to keep rates on hold this month, and the central bank may adopt a neutral policy stance going forward as they aim to balance the risks for growth and inflation. As a result, if the Governor Stevens keeps the cash rate unchanged and sees scope to hold borrowing costs steady at 3.75% throughout the first-half of the year, we will favor a bearish outlook for the high-yielding currency, and will follow the same strategy for a short aussie-dollar trade as the long position implemented above, just in reverse.

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