As was widely expected, the RBA maintained recent language around the currency. “The Australian dollar has declined noticeably against a rising US dollar over the past year, though less so against a basket of currencies. Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices.” This was not a surprise to us or to the market.
However, the lack of clearer policy guidance was a surprise. In a number of forums, including the May minutes, the RBA has used the word “scope” in relation to ‘action that might be appropriate at future meetings’. The lack of the word ‘scope’ adds some short term upside risks here.
Bond Market Perspective
The immediate bond market reaction was one of understandable disappointment that the RBA was non-committal in term of greater easing guidance, especially in light of the recent CAPEX outcomes. As a result, the yield curve initially flattened by 2.5bps, with 3yr bond yields 5bps higher and 10yr yields up by 2.5bps. The question is how much of a reversal to the recent positive momentum can we expect?
Some weak longs may still need to be shaken out, however, in our view, sentiment will not be too badly damaged by this outcome. Certainly there is scope for prices to fall further, but we are not looking for a full retracement of the recent rally. Rather we think that we are defining a new trading range over coming months – probably one that will hold into the August meeting, subject to global conditions – with 3yr futures trading a 97.90 to 98.20 range.
So we expect that support is 5-10 ticks away from current levels. Most assessments of RBA risks have as a worst case scenario that they remain on hold for a significant period. So should pricing for a 25bp cut fall below a 50% chance, that will be a good tactical buying opportunity at the front end of the curve, especially in light of the currency response to the RBA’s statement.