June 2 RBA Rate Decision (Jun) (01:30 GMT; 09:30 EDT)
Expected: 7.25%
Previous: 7.25%

What Are The Markets Facing?

The RBA rate decision will be closely watched by traders as the central bank left the possibility of a rate hike after they were more hawkish than expected at their last meeting. The MPC had considerable discussion as whether to hike rates again after they paused in April as the country experiences the fastest inflation since 1991. Expectations were that another pause would be an easy decision as a 12 year interest rate of 7.25% and headwinds from the U.S. slowdown and financial crisis were expected to considerably slow growth. However, robust demand for emerging markets has supported the economy which prompted companies to add another 25,400 jobs in April. The tight labor market has led to rising wages which along with record level food and oil prices has seen inflation in the country jump to 4.5%. However, the economy has started to show signs of slowing with retail sales unexpectedly falling 0.2% in April and manufacturing falling closer to contraction at 51.2 from 52.7 in April. Expectations are that the central bank will leave rate unchanged as the downside risks to the economy grow. Although, the country isn’t quite at risk of experiencing negative real interest rates as some of their Asian neighbors, but rising prices will remain a concern and make a rate cut prohibitive.

Bonds – 10-Year Australian Government Bond Futures

Australian government bonds have been heavy over the past month as the RBA was significantly more hawkish at its last rate decision. As fundamental data continues to point to an economic slowdown traders are paring their bets on a possible rate hike, which has provided support for bonds. The contract has found support at 93.380 but if the central bank remains hawkish or surprises with a rate hike prices will continue to fall.

FX – AUD/USD

The AUD/USD has fallen after setting a fresh 24 year high of 0.9605 on the back of record oil prices and rate hike speculation. Traders have started to sell the pair as they take profits ahead of the upcoming rate decision. Declining fundamentals have lowered the chances of a rate increase by the MPC. Yet, despite an unexpected decline in retail sales the pair failed to break below the 20 day SMA for a second day, as it has served as major support. The RBA rate decision will provide major event risk as the central bank has not sent a clear signal as to its current bias. A rate hike may send the Australian dollar to a fresh 24 year high, with a retest possible with just a hawkish statement. Although a rate reduction isn’t expected, a mere dovish statement could send the pair below support and its current trend line.

Equities – S&P/ASX 200

The S&P/ASX 200 has found support at 5620 after falling over 300 points on rising inflation and the prospect of a rate hike from the RBA. The resource sector has buoyed the index as demand from emerging markets continues to remain strong despite the anticipated slowdown due to the fallout from the U.S. slowdown and financial credit crisis. The uncertainty of the central banks bias ahead of the upcoming rate decision has traders on hold. Therefore, the decision may provide significant volatility especially if the MPC surprises with a rate hike. An increase in interest rates or a hawkish RBA mat sink equities lower as the 12 year high rate is already starting to stifle growth. Conversely, a rate reduction or a dovish bias may provide support for stocks, but may not inspire investors as the impetus for such a reaction is a dour growth outlook.

Terri Belkas is a Currency Strategist at FXCM.