AUD Trade Balance (DEC) (00:30 GMT; 19:30 EST)
Expected: -2.0B
Previous: -2.254B

House Price Index (YoY) (4Q) (00:30 GMT; 19:30 EST)
Expected: 11.8%
Previous: 10.6%

What Are The Markets Facing?

While most central banks are in the process of cutting rates – such as the Federal Reserve and the Bank of Canada – or are considering reducing rates, the markets may see something unusual next week: a rate hike. However, given the economic data on hand, a 25 basis point rate increase by the Reserve Bank of Australia may not be incredibly shocking. Indeed, the upcoming releases of the Australian trade balance and the Q4 house price index may add to the mix, as mining shipments may help to narrow the trade deficit while prices in the housing sector are forecasted to have grown at the fastest pace in nearly 4 years. Meanwhile, the RBA’s weighted-median index of inflation jumped 1.1% in Q4, pushing the annual rate of growth to a 16-year high of 3.8%. With CPI expected to hold above 3.0% during the first half of 2008 as well, it’s no wonder the central bank holds such a hawkish bias. In fact, in the policy statement from the RBA’s December meeting, Governor Glenn Stevens noted that “recent information continues to indicate strength in demand and output in Australia, with the economy having relatively little surplus capacity.” While the Board remained “concerned about the outlook for inflation,” increased “uncertainty about the international outlook and the local trends in wholesale borrowing costs” left the RBA to judge that “the current stance of monetary policy should be maintained for the time being.” Though the global outlook for growth remains uncertain and credit conditions have tightened somewhat domestically, they are no where near “crunch” conditions and as a result, the RBA may be more comfortable considering rate hikes.

Bonds – 10-Year Australian Government Bond Futures

Australian government bonds ran headlong into resistance at the 94.20 level, which has capped similar rallies over the course of 2007. Indeed, the contract has fallen quite a bit as traders ramp up speculation that the bank will raise rates in February. Upcoming data could weigh on AGBs further in anticipation of the meeting towards 93.70. On the other hand, if Australian equity markets reverse and tumble, the subsequent risk aversion could lift AGBs towards 94.20 once again.

FX – AUD/USD

As a commodity currency, it has been interesting to see that the rapid ascent of gold prices hasn’t had a bigger impact on the Australian dollar. Nevertheless, AUD/USD declines have rebounded over the past week or so as the 200 SMA served as a springboard for the pair. Looking at upcoming event risk, the release of Australian trade and housing data could propel AUD/USD higher as the figures may encourage the markets to ramp up speculation that the RBA will move to hike rates on February 4 while most other central banks are reducing interest rates or at least considering cutting rates. On the other hand, a rebound in the greenback could weigh on AUD/USD to pull the pair back down towards 0.8700.

Equities – S&P/ASX 200

While the S&P/ASX 200 has recovered somewhat since tumbling over 24 percent from the November 2007 highs to a low of 5,186.80, fears that a possible US recession and a credit crunch will impair the global financial markets could remain a stress on the index. Now that the Federal Reserve has enacted a total of 125bps in rate cuts over the past two weeks, equity markets in the Asia-Pacific region stabilized as a sigh of relief. However, the 5,860 level has capped recent rallies, and with upcoming economic data likely to support the case for a rate hike by the RBA on February 4, equities could slip once again, especially as the overwhelming trend remains to the down side. The next major level of support looms at 5,400 and should prevent further declines in the near-term.

Terri Belkas is a Currency Strategist at FXCM.