Trading Context and Influences
Traders are looking forward to China’s RatingDog Services PMI report, with predictions of a decline from 52.6 in October to 52.0 in November. A better-than-expected result could potentially support the AUD, since China’s economy plays a fundamental role in Australia’s trade.
Factors impacting the AUD include interest rates set by the Reserve Bank of Australia, the health of the Chinese economy, and Iron Ore prices. Australia’s trade balance also plays a part; stronger exports can buttress the AUD, while a deficit might weaken it.
Given the weak Australian GDP report from this morning, we see a clear signal of a slowing domestic economy. The third quarter growth of 0.4% fell short of expectations and confirms the Reserve Bank of Australia’s recent cautious stance. This follows the RBA holding its cash rate steady at 4.35% at its meeting yesterday, reinforcing the view that future rate hikes are now unlikely.
On the other side of the trade, sentiment towards the Japanese Yen is strengthening. Bank of Japan Governor Ueda’s comments have fueled speculation of an imminent policy shift, with overnight index swaps now pricing in a greater than 60% chance that the central bank will abandon its negative interest rate policy at the December 19th meeting. This potential for higher rates in Japan makes the Yen more attractive.
Potential Market Movements
This divergence in central bank policy creates a compelling case for a lower AUD/JPY in the coming weeks. We believe traders should consider strategies that profit from this downside potential, such as buying AUD/JPY put options. This allows for capitalizing on a potential drop while managing risk.
Adding to the pressure on the Australian dollar, the external environment offers little support. Iron ore futures have recently slipped below $130 per tonne, pulling back from their November highs on concerns over Chinese steel production. This comes after China’s official Manufacturing PMI, released last week, unexpectedly contracted to 49.8, indicating the recovery in our largest trading partner remains fragile.
Therefore, we will be watching two key events for further direction. Today’s China Services PMI data will provide the next clue on the health of the Australian economy’s biggest customer. All eyes will then turn to the Bank of Japan’s policy meeting on December 19th, which could be the main catalyst for a significant move in the pair.
