The Australian Dollar rallied to test 0.7300 having traded as low as 0.6985 in US hours as the Reserve Bank of Australia shocked the markets, issuing a full 100 basis point interest rate cut. The market cheered on the announcement: US stock futures rose while Treasuries and the Japanese Yen declined. This sends a clear message to central bankers, opening the door to speculation of coordinated rate cuts in the days ahead.
Key Overnight Developments • Reserve Bank of Australia Doubles Down, Cuts Rates by 1% • Bank of Japan Retains Rates at 0.50% Citing “Sluggish” Growth Critical Levels The Euro and British Pound gained ground in late Asian session trading, testing above 1.36 and 1.76, respectively. Forex traders sold the US dollar as risk appetite perked up after Australia’s central bank issued a massive interest rate cut (read below). Asia Session Highlights The Reserve Bank of Australia shocked the markets, issuing a full 100 basis point interest rate cut, the largest since 1992, to bring borrowing costs to 6.00%. RBA Governor Glenn Stevens said the move owed to “a material change” in the risk to expectations for growth and inflation as international financial markets have taken a “significant turn for the worse”. Stevens now sees the potential for output to decline faster than originally forecast as even creditworthy borrowers are unable to obtain required capital. Still, the Governor was careful to avoid setting a precedent, saying extraordinary circumstances required “an unusually large” reduction in the benchmark lending rate to relieve credit markets but that the RBA did not “regard that movement as establishing a pattern for future decisions.” While interest rate cuts are typically bearish for a particular currency, the Australian Dollar rallied to test 0.7300 having traded as low as 0.6985 in US hours. Traders saw welcome relief in the move as credit markets seize up worldwide. Risk sentiment was noticeably responsive: Australia’s benchmark S&P/ASX 200 index added about 2% and US equity indices rose an average of 1.3% while Treasuries and the Japanese Yen declined. The Bank of Japan validated market expectations, keeping borrowing costs at 0.50% while saying that “economic growth has been sluggish and these conditions may persist for some time.” The world’s second-largest economy is now formally in recession and has recently seen its trade surplus reverse into negative territory as overseas demand succumbed to the global slowdown. Augusts’ preliminary Leading Index printed at 89.3, the lowest in 6 years. Euro Session: What to Expect The flood of red ink shows no signs of ebbing in European trading hours. In the UK, Industrial Production is expected to shrink -2.0% in the year to August while Manufacturing Production loses -1.6% in the same period. Both readings will represent the lowest points in 3 years for their respective metrics. Hard industry is equally under pressure across the English Channel as Germany’s Factory Orders are set to lose -4.7% in the year to August, printing within a hair of the 5-year low. The dismal fundamental tone is nothing new: top European economies have been flirting with the prospect of recession for some months. Indeed, trading in index swaps points to market expectations of 125-150 basis points in interest rate cuts for both the European Central Bank and the Bank of England over the next 12 months. On balance, risk sentiment is likely to remain as the dominant factor moving forex prices. The markets sent a clear message to policymakers following the RBA’s massive rate cut: slash borrowing costs and confidence will return. The door is now open to speculation of coordinated monetary easing from the world’s top central banks in the days ahead. Related Articles: Forex Technicals: The Day Ahead, October 7 Dollar Rises And Japanese Yen Surges As Financial Crisis Spreads (Forex Video) To contact Ilya regarding this or other articles he has authored, please email him at ispivak@dailyfx.com.