Synopsis:

The latest RBA minutes reinforced the central bank’s hawkish stance, supporting the undervalued AUD/USD. Despite a modest rally in AUD/USD driven by softer USD conditions, markets still expect rate cuts, keeping pressure on the pair.

Key Points:

• Hawkish RBA Minutes:

  • The RBA emphasized that monetary policy must remain restrictive until inflation returns sustainably to the 2-3% target, projected for 2026.
  • Trimmed mean inflation remains elevated at 3.5% YoY, despite falling fuel and electricity prices lowering headline inflation to 2.8% YoY in Q3.

• Policy Scenarios Considered:

  • Rate cuts could be considered if consumption weakens further or the labor market deteriorates faster than expected.
  • Rate hikes remain on the table if consumption strengthens or the labor market remains tight.

• Economic Indicators:

  • Modest pick-up in consumption driven by income tax cuts and electricity rebates, though households are largely saving these gains.
  • The labor market remains tight, with the unemployment rate steady at 4.1%, slightly below the RBA’s 4.3% year-end forecast. Underemployment is declining again.

• Market Reaction and AUD/USD Dynamics:

  • Australian rates markets have shifted from pricing in 40bps to over 50bps worth of rate cuts over the coming year, aligning with a rally in US rates.
  • The weaker USD has driven a recovery in AUD/USD, supported by Credit Agricole’s FAST FX model, which is long AUD/USD.
  • The short-term fair value for AUD/USD is estimated at 0.6586, suggesting room for upside correction.

Conclusion:

The RBA’s hawkish rhetoric and tight labor market dynamics provide underlying support for the AUD, even as markets price in rate cuts for 2024. With a softer USD creating near-term tailwinds, AUD/USD could continue its recovery towards fair value, though downside risks persist amid global and domestic uncertainties.