From RBA, the rate cut in May month has nothing to do with growth, and everything to do with inflation.
More RBA cuts in the months to come and we reckon this is not completely priced in, the RBA surprised the market and us in cutting the cash rate target by 25bp to 1.75% in May.
When the Reserve Bank of Australia (RBA) cut the cash rate target by 25bp in May it was clear to pretty much every observer that it was the shockingly low Q1 inflation report that was the main motivation.
The most unexpected RBA rate cut at the May meeting was entirely driven by a sizable downward revision to the inflation outlook.
Clearly, this decision was motivated by the severe downgrade of the central bank inflation outlook. In particular, wage growth is plunging and disanchoring from the unemployment rate.
Price dynamics are being significantly reassessed by the board, with the end-2016 forecast lowered by 1% and reduced rates until mid-2018. This strongly suggests that the latest cut is not a one-off and that at least one more cut is to come this year.
The upcoming national elections certainly prevented a June cut, while August is probably inappropriate since new economic forecasts will be discussed.
The rates market is pricing a 40% probability of a 25bp cut between August and the end of the year, so an earlier cut or more cuts would trigger a sharp market reaction and hurt the AUD. A first rate cut in July is our main scenario, and globally we believe that a cut of at least 50bp is appropriate.
The time is now right to increase bearish AUD positions via options since the RBA is not finished making cuts and China’s bumpy landing will see sentiment remain fragile.
The positioning reported by the CFTC also suggests a potential turning point. The long speculative positions are just turning short, and since 2001, this pattern always coincided with an acceleration of the bearish positioning. The reversal initiated at 0.75 when long positions peaked is probably not over, so a repricing of the RBA rate path could increase the shorts and accelerate the bearish move.
Buy reverse knock-out put to trade gradual and limited AUD decline – hold it to maturity We recommend Buying a 6m put strike 0.72 with a knock-out set at 0.65.
AUD/USD is falling below year-to-date low. Investors buying a knock-out option cannot lose more than the premium initially invested. The option will, however, cease to exist if AUD/USD touches 0.65 at any time before the 6m expiry.
The material has been provided by InstaForex Company – www.instaforex.com