AUD/USD slides after 2Q CPI misses expectations
The headline inflation measure fell unexpectedly in the second quarter, printing at 1.9%y/y versus 2.2% expected and down from 2.1% in the previous quarter. This lacklustre reading should be viewed in the context of significantly overly optimistic market participants about the eventuality of a tightening move from the Reserve Bank of Australia. AUD/USD slid 0.50% to 0.7878 this morning as investors priced in the info.
Looking at the details, there is no reason to panic as the core measure remained stable, with the trimmed mean holding up at 1.8%y/y while the weighted mean edged up to 1.8% from 1.7%. Most of the decline in the headline measure is to falling automotive fuel and food and non-alcoholic beverage prices. Overall, tradable components fell 0.3%q/q, while non-tradable components rose 0.4%q/q.
Despite a minor reversal, the Aussie held ground on Wednesday as investors continue to anticipate the RBA will start lifting borrowing costs as soon as Q2 2018. We take a more cautious approach as we believe the central bank is also keen to keep the Australian economy competitive on the international level and with falling inflation measure across the globe, a delay in the tightening process is more than likely.
In the FX market, the Australian dollar had a nice ride since early May. The Aussie rose more than 7% against the greenback, 6.40% against the pound sterling and 5.30%against the Japanese yen. However, we believe there is room for a correction, especially against the US dollar. Indeed, speculators have bet heavily on the Aussie as highlighted by the latest CFTC’s COT report. Long AUD speculative positions rose the highest level since 2013, reaching 43.60% of total open positions. This extreme positioning together with the AUD’s recent sharp rally will likely trigger some significant profit taking. AUD/USD has been unable to break the 0.80 threshold to the upside. From our standpoint, a correction towards the 0.76 area would be more than healthy.
FOMC up next
The divergence between surveys and hard data in the US continued yesterday. The Conference board’s index of consumer confidence increase to 121.1 in July assent expectations for marginal decline. When you compare this to the negative trend in retail sales investors, have a distorted perspective of the US economy. We take a way two key points in this situation, first is that the real economy is underperforming expectations and second that the Fed threshold of reducing their blotted balance sheet is significantly lower than increasing interest rates.
Weak USD was built on the expectations of no hikes in 2017 but seems to sidestep the potentially more destabilizing effect of exit on global yields. Yield spread differentials between US and G10 nations have narrow while VIX index has fallen to new historical lows. Reads suggest that there is limited risk with the Feds current policy path. Markets are uniquely focused on inflation to their detriment, as in our perspective the Fed will continue to tighten via balance sheet reduction regardless of inflations levels.
For today’s FOMC meeting we don’t see any real market impact. We anticipated slight adjustment in languages highlight the transitory weakness inflation and stronger labor markets. More importantly we don’t expect any additional clarity on the fed exit strategy which will likely come in September. USD has become increasingly sensitive to interest rates and with limited expectations for repricing Feds interest rate path, today a reversal in USD is unlikely. Yet additional USD weakness is unlikely do to overstretch short position unless the Fed becoming meaningfully dovish.
