AUD/USD: Trading the RBA Interest Rate Decision

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Monday, 04 May 2009 11:21:00 GMT
Written by David Song, Currency Analyst
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The Reserve Bank of Australia is expected to hold the benchmark interest rate steady at the 49-year low of 3.00% as the board adopts a wait-and-see approach, and long-term expectations for higher interest rates could boost demands for the Australian dollar as market sentiment improves.

Trading the News: RBA Rate Decision

What’s Expected

Time of release: 05/05/2009 04:30 GMT, 00:30 EST
Primary Pair Impact: AUDUSD
Expected: 3.00%
Previous: 3.00%

Impact the RBA Rate Decision had on AUDUSD over the last 2 months
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Apr 2009 RBA Rate Decision

The Reserve Bank of Australia lowered the benchmark interest rate by 25bp to a 49-year low of 3.00% as the region faces its first recession since 1991, and went onto say that the extraordinary efforts taken on by policymakers will help to ‘provide significant support to domestic demand.’ Governor Glenn Stevens said that the $1T economy will contract this year, and stated that there was only room for a ‘modest adjustment’ in April after the growth rate unexpectedly fell 0.5% in the fourth quarter, which is the first contraction since 2000. Moreover, the central bank noted that demands for employment is ‘weakening,’ while ‘demand for credit is weak overall,’ and said that policymakers expect GDP ‘to fall in 2009’ as the downturn in the global economy intensifies. The comments suggests that the RBA may continue to ease policy further as growth prospects deteriorate, and may step up their efforts as trade conditions falter.

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March 2009 RBA Rate Decision
The Australian central bank held the cash rate steady at the 45-year low of 3.25% amid expectations for a 25bp cut, which suggests that the RBA may keep rates on hold after taking unprecedented steps to stimulate the $1T economy. RBA Governor Stevens said that the extraordinary measures taken on by the government and the central bank will provide ‘significant support’ to the economy, but went onto say that ‘weak conditions are likely to continue in the near term’ as nation teeters on the brink of a recession. Despite the encouraging comments from the central head, the outlook for growth and inflation remains bleak as the downturn in the global economy intensifies, and conditions are likely to get worse as trade conditions falter. Nevertheless, as policymakers adopt a wait-and-see approach, weakening fundamentals could spark another round of easing as growth prospects deteriorate at a rapid pace.

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What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:

If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the AUD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on AUDUSD ahead of the data release.

Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the AUD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on AUDUSD ahead of the data release.

How To Trade This Event Risk


The Reserve Bank of Australia is expected to hold the benchmark interest rate steady at the 49-year low of 3.00% as the board adopts a wait-and-see approach, and long-term expectations for higher interest rates could boost demands for the Australian dollar as market sentiment improves. A Bloomberg News survey shows that 18 of the 19 economists polled forecast the RBA to hold the overnight lending rate steady even as the central bank expects the $1T economy to contract this year, and commentary following the rate decision is likely to spark volatility in the currency markets as investors weigh the outlook for future policy. Governor Glenn Stevens said that the nation is facing its first recession since 1991 following the 25bp rate cut last month, but held an optimistic outlook for future growth as he expects the ‘rapid deployment of both fiscal and monetary measures’ to ‘provide significant support to domestic demand,’ and went onto say that ‘there remain good grounds to think that we will continue to weather the storm better than most.’ Despite the encouraging comments from the central bank head, retail spending, which accounts for nearly half of the economy, fell in February for the first time in five-months, while the unemployment rate surged to 5.7% in March from 5.2% in the previous month to mark its biggest advance in 18-years, and the data foreshadows a weakening outlook for growth and inflation as economic activity deteriorate at a record pace. In addition, job advertisements plunged 49.9% from the previous year to reach a record-low in April, while manufacturing contracted for the eleventh month in April to 30.1 from a revised reading of 33.2, which is the lowest reading on record. At the same time, the Westpac leading index fell at an annualized pace of 5.1% in February to post its largest contraction since 1982, while house prices in the first quarter fell 6.7% from the previous year, which was the biggest decline since recordkeeping began in 1986, and conditions are likely to get worse as households face a weakening labor market paired with tightening credit conditions. As the region faces a deepening downturn, policymakers may take further steps to shore up the economy as the International Monetary Fund forecasts GDP to contract 1.4% this year, and as the group calls for the RBA to lower borrowing costs further to stem the downside risks for growth and inflation, Governor Stevens may surprise the market with a rate cut as trade conditions falter. Nevertheless, Mr. Stevens stated that ‘the clearest sign of a turning point in economic activity appear to be accumulating in China,’ and as the RBA governor holds an improved outlook for Australia’s biggest trading partner, policymakers may adopt a neutral policy stance over the medium-term as they anticipate increasing demands from the world’s third largest economy to drive growth in the isle-nation. As a result, if the central bank concludes its easing cycle this month, we are likely to see increased demands for the Australian dollar as market participants move into higher risk/reward investments, which could lead the aussie-dollar to retrace the sell-off from October as investors raise long-term prospect for higher interest rates in the $1T economy.

Trading the given event risk favors a bullish outlook for the high-yielding currency as market participants speculate the RBA to hold the cash rate steady this month, and price action following the rate decision could set the stage for a long aussie trade as investors raise the appetite for risk. Therefore, if the central bank puts a floor on the interest rate and adopts a neutral policy stance going forward, we will look for a green, five-minute candle subsequent to the announcement to confirm a buy entry on two lots of AUD/USD, and once these conditions are met, we will place our initial stop at the nearby swing low (or reasonable distance taking volatility into account), and this risk will establish our first target. Our second target will be purely based on discretion, and in an effort to preserve our profits, we will move the stop on the second lot to breakeven once the first trade reaches its target.

On the other hand, the downturn in the labor market paired with fears of a deepening recession may lead the reserve bank to take additional steps to stem the downside risks for growth and inflation, and an unexpected drop in the interest rate is likely to weigh on the exchange rate as investors expect the RBA to adopt a neutral policy stance. As a result, if policymakers lower the cash rate by 25bp or more, we will look to sell the higher-yielding currency, and will follow the same setup for a short aussie-dollar as the long position mentioned above, just in reverse.

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