Australian Dollar Plummets as Central Bank Leaves the Door Open to More Rate Cuts

The Australian dollar dropped sharply against its U.S. counterpart Tuesday following strong gains Monday after the Reserve Bank of Australia (RBA) made a negative assessment of the economy. The bank kept rates on hold at 2.75 percent after unexpectedly cutting rates in April from 3.00 percent and keeping them on hold in May.

David Song, currency analyst at Daily FX, weighed in on the moves to Benzinga. "The Australia dollar struggled to hold its ground following the Reserve Bank of Australia interest rate decision as Governor Glenn Stevens left the door open to push the benchmark interest rate to a fresh record-low, but the higher-yielding currency may regain its footing over the next 24-hours of trading as the 1Q GDP report is expected to show the $1T economy expanding at a faster pace."

"Indeed, Australia is expected to grow another 0.7% following the 0.6% expansion during the last three-months of 2012, and the faster rate of growth may heighten the appeal of the aussie as it dampens the RBA's scope to lower borrowing costs further. However, a dismal print may spark fresh lows in the AUDUSD as it fuels speculation for another rate cut, and the central bank remains poised to further embark on its easing cycle in the second-half of the year in order to stem the downside risks for growth and inflation.""

Scope for Easing

In the statement accompanying the rate decision, the RBA Board stated that there was "scope for further easing" should the economic outlook worsen. This spooked traders as the last time they made similar statements earlier this year, they proceeded to cut rates.

The RBA Board also noted that financial conditions in Australia improved recently as a result of proactive policy. The Board sees the current financial conditions as a platform for future growth as the economy is forced to diversify away from mining exports.

Inflation Outlook

Also weighing on the Aussie dollar were comments from the Board on the inflation outlook for Australia. The Board noted that the inflation outlook may provide some scope for further easing should it be required to support demand. They also added that the current policy (i.e. rate level) is appropriate given the inflation outlook.

However, the Board also noted that the Aussie dollar remains strong despite recent weakness in commodity prices. The drop in commodity prices in April has not yet abated and weighs on exports. Thus, the relative strength of the currency could imply that there is room for further devaluation and upside to inflation.

Technicals

Technically, the Aussie dollar gapped higher against the U.S. dollar on Monday from a low of 0.9637 to 0.9792. Tuesday, the currency "filled the gap" and retraced the entire move higher. Currently, the pair trades 0.9629, down 1.24 percent on the session.

Declines were not limited to those against the greenback. The Aussie dollar also fell similar amounts against the euro, the Swiss franc, and the British pound and less-so against the yen and the Canadian dollar.

Outlook

Australia's latest revision to first quarter GDP is due out overnight tonight and should be the next risk event for the currency. Economists surveyed by Bloomberg forecast that the economy grew 0.7 percent in the quarter and 2.7 percent on an annualized basis.

Expert Opinion

John Kicklighter, Senior Currency Strategist at Daily FX weighed in on the recent moves in Australian dollar. “The Australian dollar's universal losses today are a mirror of the market-wide gains forged the previous day. The magnitudes are roughly the same as well, which suggests a correction of the previous move."

"By many accounts the Aussie dollar is oversold in the medium-term after the aggressive decline over the past month against both low yield and rival investment currencies. In equities, we still see a chase for yield where even historically low rates of return have spurred incredible demand to ‘take advantage of the market advance'. That hasn't been the case for the FX and certainly not the Aussie dollar."

"Currencies may very well show an early change in attitude towards the ‘any yield at any cost' mentality, but we have yet to see market-wide adoption. In the meantime, the Australian currency had an unfavorable turn at the economic table. The RBA pulled back on the bulls by reminding those that are hoping for rate hikes, that there was still scope for easing. And, while the 1Q current account balance showed a bigger drop in the deficit than expected; it also revealed the lowest foreign holdings of Aussie-dollar based government debt since 3Q 2010. A big factor in the strength of the currency over the past years is the inflow of investment capital into the country.”