RBA: FX and rates market response to July rate decision - Westpac

Unsurprisingly, the RBA kept rates on hold at 1.5% and the guidance around the AUD was also unchanged, repeating the familiar line that “[a]n appreciating exchange rate would complicate this adjustment” in the transition in the economy following the mining investment boom, notes the research team at Westpac.

Key quotes

“We had expected “that the July policy meeting [was] unlikely to deliver any major shifts in policy or rhetoric”. And indeed, the final conclusion paragraph was unchanged, and the tweaks were net neutral. Markets however appeared to be positioned for more optimistic changes to the statement, likely after the more positive commentary from other major central banks (Bank of England, Bank of Canada, ECB) at the Sintra conference. The AUD dropped from a little above 0.7680 to as low as 0.7622.”

“We had been watching the topside for the AUD more closely in the past few sessions, seeing resistance around 0.7700/10 then 0.7750. With the US dollar strength yesterday and the reaction to the minutes decidedly negative for the currency the downside support levels of 0.7590/00 come more closely into focus. Near term though, below 0.7540/60 seems unlikely.”

“Rates Perspective

• Australian bond yields have fallen across the curve in response to the Governor’s Statement. While there was nothing particularly surprising from our point of view – we certainly did not think that the RBA would join a “hawkish coalition of central banks” – there was clearly a residual of market participants holding out for that sort of outcome. As a result, 3yr futures have rallied around 4-5 ticks, with 10yr futures up around 2-3 ticks following the announcement. 
• As to how far the market could rally, there was already a sense that the clean-out of long positions that had driven last week’s price action had largely run its course. So there is some scope for a squeeze higher.  However, we remain somewhat at the mercy of global bond market machinations and given current sentiment and momentum, we would therefore not expect much follow through buying near term. Indeed, we continue to believe that there will be as much propensity to establish tactical shorts into any further strength as there would be interest in buying dips on a 10-15 tick move lower from here. 
• From a cross market perspective, it certainly appeared that we had seen the worse of the AU bond underperformance over the past week during the overnight session, with the AU-US 10yr bond spread narrowing around 5bps from its early Monday opening level. Optically, the spread has narrowed even further on the outcome, although there is no UST trading. In any case, this should support and consolidate our long held view that widening should be faded. We expect AU-US 1y1y narrowers, which were already popular, to remain firmly on the radar.”