Hopes of new rate cut rise with the dollar

The deal on the US debt ceiling has given the Aussie a boost, writes Glenda Kwek.

The Australian dollar has risen to new four-month highs, reviving expectations of another Reserve Bank rate cut, as the US budget and debt ceiling turmoil reduced prospects of a near-term reduction of the Federal Reserve's stimulus program.

Global markets were nervous but fairly muted this week, rallying modestly after uncertainty over the political impasse that threatened to plunge the US into a debt default was lifted just hours before a US Treasury deadline.

The Australian currency rose about US1¢ early Friday to trade as high as US96.47¢, a level it has not touched since mid-June, as the US dollar weakened across a range of currencies. It was buying US96.22¢ late Friday.

The dollar's strength, which has seen the currency recover about 8 per cent of its value since sinking to US89.01¢ in late August, came as Reserve Bank governor Glenn Stevens said in Sydney on Friday that a "lower currency than this would be helpful in rebalancing the growth sources of the economy".

"I'd prefer it to be lower than this rather than higher," he said.

The US government shutdown and debt ceiling crisis, which was resolved on Thursday, was estimated to have eaten into US fourth-quarter GDP. It raised the possibility the Fed could keep its $US85 billion-a-month stimulus program running until the economy showed more sustained signs of growth.

The stimulus program commenced in September 2012 and has seen investors flocking to riskier assets such as the Australian dollar.

The short-term debt deal, which will see the US government funded until January 15 and raise the debt ceiling through to February 7, also raised the likelihood of another round of fiscal battles early this year.

Analysts had expected the Fed to start winding back its program from December. But some have since pushed back their expectations of a start to tapering to early next year after the political battle.

Chicago Federal Reserve Bank president Charles Evans said on Thursday that "it is not yet time to remove accommodation".

"I believe this program should continue until we are confident that there has been a sustainable improvement in the labour market," Mr Evans said.

His views were echoed by Minneapolis Fed president Narayana Kocherlakota, who said that talk of stimulus reduction at this time "sends exactly the wrong message".

Such expectations that tapering would be delayed have in turn weighed on the US dollar, with the greenback declining against a range of currencies, including the Australian dollar.

"While the US quantitative easing taper is delayed and global growth remains stable at or close to trend, the Australian dollar may grind gradually higher," said RBS senior currency strategist Greg Gibbs in a note. "The next month or three may be one of the weakest periods for the US dollar since late 2010-11."

Westpac chief economist Bill Evans said on Friday that the US political wrangling and tapering delay would be supportive of a Reserve Bank rate cut.

"At present markets are giving less than a 30 per cent chance of another rate cut from the RBA, with rates confidently priced to be rising from September next year," said Mr Evans, who forecasts the central bank will ease rates two more times before it reaches the end of its current easing cycle.

"We expect that to change quite significantly over the course of the rest of this year."

Also on Friday, Goldman Sachs analysts pushed back their next cash rate cut from November to March next year.

Third-quarter CPI data released next Wednesday is expected to point to a subdued inflation outlook, leaving the Reserve Bank room to reduce the cash rate again.

Financial markets are pricing in a 10 per cent chance of a Reserve Bank cut next month, Bloomberg data showed. Expectations of another cut then rise to more than 35 per cent by March next year.

At the same time, the Australian dollar recent rise has been boosted by several factors including improving commodity prices and the strengthening of second-quarter Chinese data.

Iron ore prices, in particular, have remained strong despite the increase in export volumes.

"The rebound in the [Australian dollar] since the end of August in particular has been supported by higher commodity prices," Westpac senior currency strategist Sean Callow said. "It's been noticeable how resilient iron ore is. The value of Australian exports, iron ore in particular, is going to be very strong."

A subdued outlook for China in the first half of this year as it shifted away from investment-led growth has been replaced by greater optimism about Australia's largest trading partner, spurring support for the Australian dollar.

China's GDP grew 7.8 per cent year-on-year from July to September after two quarters of slowing growth, figures released on Friday showed.

Despite the pessimism surrounding the US economy at this time, which has weighed on the US dollar, Mr Callow said he expected growth to pick up in the medium to long term.

US bond yields were falling again in what would be a boost to the housing market, while the US economy was undergoing a shale gas boom that could see the country become a leading energy producer, he said. "There are very clear positives for the US in the longer term that make us reluctant to extrapolate dollar weakness too far."