Apr 24, 2012

Australian Dollar's Double Jeopardy

This week it feels like the AUD was punished twice for what is essentially the same "crime". On Monday morning Asian time, the Producer Price Index (PPI) disappoints, coming out 0.6% lower than expected. The Australian dollar promptly sells off against the USD and JPY. This makes perfect sense - lower PPI generally feeds into lower inflation, thus an increased likelihood of a rate cut at the next RBA meeting. So far so good.

Overnight, SPX stabilizes and most "risk" currencies bounce a little in line with the equity market. On Tue morning Asian time, Australia's Consumer Price Index disappoints by a roughly equivalent amount. On this data release, the AUD drops again.

Now the CPI weakness should have already been priced in. It is, of course, theoretically possible for PPI and CPI to diverge. For example in an economy where natural resources are mainly imported and their prices are going up (pushing up PPI), but the domestic economy is slowing so consumer spending is sluggish (reducing pricing power and thus lowering CPI). In general though, the 2 measures of inflation usually move together.

So what happens next? It is hard to say with any amount of certainty, but let us not forget the employment numbers from last week. (Australia's economy created 44k jobs, beating estimates.) This will likely to give RBA's Glenn Stevens an excuse not to cut rates as much as the market is hoping for. Quarter point cut seems already completely discounted and the market is even starting to talk of a half point cut. Stevens has been reluctant to cut in the past even with inflation quite subdued and the economy slowing. The environment may be ripe for a positive surprise and a bout of short-covering. It was only a week ago that Nomura was recommending a long Aud/Usd position with a target of 1.08 (currently ~ 1.0250).

(For other WhatIf posts, click here)