Credit Suisse with the note. I will take the dovish under on every forecast here:
We see markets as unwilling to test the RBA’s dovish resolve ahead of the May meeting. The potential for a conservative government budget on May 11 may further re-contextualize the RBA’s policy as dovish. This outlook reinforces our expectation for AUDUSD to trade in a 0.7415-0.7800 range.
Long-term RBA forecasts to refocus dovish policy message
Since we flagged risks that Australia’s COVID situation might represent forAUDUSD on 14 April, AUDUSD has rallied to the top our expected 0.7415-0.7800 range. The two first weeks of May now present 3 potential catalysts for a change in AUD price action: the May 4 RBA rate decision, followed by the May 7 Statement of Monetary Policy (SOMP) and the May 11 budget.
Ahead of the 4 May decision, markets expect the bank to leave its cash rate and 3-year target at 0.10%. In its February meeting, the RBA introduced forward guidance indicating that the cash rate would remain unchanged until inflation is sustainably within the 2% to 3% target range, criteria which they do not expect to meet until “at least 2024”. Markets largely do not anticipate a change in language on this front.
Beyond forward guidance, the immediate item on the RBA’s calendar is the expiration the Term Funding Facility in June 2021. The TFF, launched on March 2020, provides low cost three-year funding for authorised deposit-taking institutions (ADIs). The RBA flagged in its most recent minutes that A$95bn had been drawn to date, and that A$95bn was available until the end of June. In the Feb SOMP, the RBA flagged that other central banks (FOMC, ECB, BoC) have discontinued their respective emergency lending facilities. With funding markets relatively stable now, it is possible that the RBA will let this program expire: this would likely not be viewed as a surprise, in light of previous language.
On the asset purchase front, markets will be on the lookout for further information on both of the RBA’s asset purchase programs: the YCC, which targets the benchmark 3yr bond at 0.10%, and the second iteration of its100bn QE program, projected to end on October 2021 (the previous one was announced on 3 Nov 2020, and its 100bn capacity was exhausted by 12 Apr 2021).
Focus will be on whether the RBA will shift its YCC purchases from the April 2024 bond to the November 2024 bond. Since the most recent RBAdecision on 6 Apr, the spread between Nov 2024 and Apr 2024 bond yields has widened, suggesting that markets see lower likelihood of the RBAswitching from the April 2024 to the November 2024 bond compared to a month ago. We also note that at the time of the Feb/Mar 2021 bond market sell-off, the RBA preferred increasing repo costs associated with borrowing 3ybonds to address market turbulence, rather than permanently increasing the pace of purchases, or pushing operations further out on the curve. This suggests a high bar to extending YCC: as such, we think that rolling over its3yr target to the November 2024 point is certainly not impossible, but would likely at this point represent a fairly dovish surprise.
As for QE purchases, the RBA said in its 6 Apr rate decision that it was prepared to undertake further bond purchases if needed, cementing market expectations that they will extend the current program once it ends in October 2021. We suspect the 4 May decision or the 7 May SOMP might be too soon for the RBA to signal a potential extension. This said, it is worth highlighting that the RBA certainly has plenty of dry powder: as a proportion of government bonds outstanding, the RBA still owns a smaller amount of the local market than its peer G10 central banks. Furthermore, unlike the RBNZ who is legally limited to owning no more than 60% of outstanding bonds, the RBA is not constrained by any legal proportional ownership limits. We think this represents an important distinction that might prevent markets from pricing in the possibility of an earlier or faster reduction in RBA asset purchases if data were to warrant it, especially compared to countries like Canada and Sweden where dislocation effects from central bank purchases have been firmly in focus.
With no actual change in policy expected at the 4 Mar decision, the spotlightwill be on the Statement of Monetary Policy on 7 May, and on any possible forecast updates. The RBA’s February forward guidance indicated that the bank does not foresee a rate hike until it reaches its 2-3% inflation goal: with the Feb SOMP forecasting CPI at 1.75%yoy in Jun 2023, the RBA would have to aggressively revise its CPI estimate higher in order to challenge the existing forward guidance. On the other hand, the Feb SOMP did not forecast unemployment to reach current levels of 5.6% until mid-2022, suggesting that a large upgrade is in order. GDP growth is expected to peak at 8%yoy in June 2021, and then stabilize in mid-3% out to 2023.
Risks to the RBA’s external accounts forecasts are likely to the upside. Future front contracts for iron ore, Australia’s largest export, are now hovering around$190, 30% higher than prevalent prices at the time of the previous SOMP.While the bank does not provide specific forecasts for iron ore prices, it stated in its Feb MPR forecast that “iron ore prices are expected to decline over the forecast period”, indicating it may have not accounted for such an aggressive appreciation in its main export product.
The stronger tone of recent data relative to RBA expectations therefore suggests risks of a more upbeat set of forecasts in next week’s SOMP. This said we suspect that lingering dark clouds might allow the RBA to hold back in fully marking to market its forecasts. The most delicate issue is the persistently slow wage growth: in Q4, the Wage Price Index that the RBA tracks grew 1.40% qoq, only slightly better than the RBA’s expected 1.25%qoq. While the RBA had already flagged in its Feb SOMP that “forward indicators suggest wages growth will remain soft this year”, the limited improvement since then suggests that lower than expected unemployment rate alone might not be viewed as sufficient to warrant a sharp change of tack on the policy guidance front. Another issue, discussed at length in our14 April FX Compass, is the slow vaccine rollout. In its February SOMP, the RBA specified, “the domestic vaccination program is assumed to proceed in line with government guidance”, suggesting that the abandonment of all vaccine goals on 11 April amid severe delays represents a deterioration versus the RBA’s base case.
While the RBA’s Statement of Monetary Policy is an ideal occasion to support any major policy shifts, it is also the case that fiscal policy has had a large role in shaping the RBA’s forecasts. With the 11 May budget around the corner, we also think the RBA may opt to wait for clarity on the government’s intentions on fiscal support.
Government budget update carries RBA policy implications
In Sept 2020 Finance Minister Frydenberg said that the government would maintain fiscal support until the unemployment rate was comfortably below6%. In the October 2020 budget, the government forecasted the unemployment to average 7.25% during the 2020-21 year: unemployment rate instead is now at 5.60%, putting the fiscal rectitude discussion squarely on the map. The previous short-term budget, presented on Oct 2020, encouraged spending through wage-subsidies and through a series of tax-breaks: this coming budget instead is likely to be a balancing act between increased fiscal prudence and continuation of support measures. While the business community is pressuring for expansionary measures such as a 20%investment allowance, the backdrop might instead indicate that the government will soon tighten its belt. The government kicked off the “tightening” when it allowed JobKeeper, its wage subsidy program, to expire in March 2021. This supported expectations that the traditionally conservative government, which in pre-pandemic times ran on the promise of balancing the budget, would seek to rein in spending again. If the government does present a conservative budget, this however might allow the RBA to keep its asset purchases unchanged but appear to be more dovish as it would be taking in a larger proportion of the presumably reduced debt supply.
China tension risks still not urgent
While we do not expect Sino-Australian relations to become an FX driver, the latest escalation in diplomatic tensions with China, namely the cancellation of the Belt and Road initiative agreed between China and the state of Victoria, is a risk to monitor. Insofar as China continues to depend on Australia’s iron ore exports, we see the risk AUD from this issue as still contained. The latest data validates our view: China customs data published on 13 April showed iron ore imports rose 18.9%yoy to 102.11 million tonnes in March.
We nevertheless see tensions with China as an added reason to be cautious ahead of next week’s events. In absence of a significant pickup in the RBA’sinflation forecasts, markets will likely be unwilling to test the RBA’scommitment to its 2024 guidance. Markets do not expect the May 11 budget to represent a significant upgrade to spending projections, and if anything, a potential contraction in expected debt supply increases points to risks that theRBA’s QE program is seen as larger and more dovish. We see these monetary policy risks as reinforcing our expectation for AUDUSD to trade in a 0.7415-0.7800 range for the time being.
