MARKETS SPECTATOR: Rating the dollar

The Australian dollar is starting to hover very closely around the $1.03 mark. That suggests a rate cut may not be on the cards for Melbourne Cup day.

Trapped in a cage

The Australian dollar is trapped between the prospect of further rate cuts, possibly as soon as Cup Day and a general pickup in global economic data since the October rate cut decision.

And yesterday’s news didn’t do anything for the rate cut pundits either, as both the latest inflation figures and Chinese flash PMI data came in stronger than expected, with 3 month overnight index swap futures now pricing in a rate of 2.9 per cent, up from 2.8 per cent a day earlier. And the odds of a cut dropped significantly too with interbank futures showing a 63 per cent chance of a cut at close of business yesterday, down from 85 per cent on Tuesday.

If there’s one thing the doves will be hanging their hat on, it’s the RBA’s long stated intention to look through the impact of the carbon tax on inflation. The Reserve Bank’s statement from October’s meeting that it is appropriate for the stance to be "a little more accommodative” suggests a November cut was never the ‘sure bet’ everyone had been spruiking.

That said and done, rates aren’t going to the extreme levels predicted by the futures market just a few weeks ago.

By cutting rates below the GFC level of 3 per cent, the RBA will trigger the "are things now worse than the GFC?” question.

So, whilst they’re going lower over the next few months it’s looking like a rate cut might not be the best bet on Melbourne Cup day after all, with it likely to be a line ball call at best.

The charts are confirming this too, depicting a good old ‘tug o war’ battle between the bulls and bears when it comes to the Aussie dollar, a good proxy for interest rates.

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Source – Iress

The above weekly chart shows very clearly the topside resistance around the 1.06 mark and downside support around and just below the 1.02 handle.

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Source – Iress

Zooming in further, the above daily chart shows the well-defined trading range for the Australian dollar. Interestingly, the most recent high around the 1.04 level may prove to be resistance too, meaning the range would be getting even tighter.

Either way, it’s telling us that there really is no clear direction for the Aussie at the moment, with neither the bulls nor bears in complete control. It wasn’t long ago that interest rate futures were predicting rates as low as 2.25 per cent. If this was the case and the market really did believe it, I think the above charts would depict much more downside bias.

While it looks like the Australian dollar has peaked during this cycle, it’s becoming more apparent that the decline is going to be more of a gradual grind lower rather than a brutal sell off. On one hand there are the hallmark signs of an overvalued Australian dollar; like China’s slowdown, falling commodity (iron ore and coal) prices and a central bank that has been cutting for the best part of a year.

However, balancing these points are its triple-A rating and huge yield differential that continues to attract offshore fund flows. Gravity will eventually win this battle and pull the Australian dollar back below the parity mark, much to the applaud of the creaking economy. Months, rather than weeks of patience may be required.