Aussie at the mercy of liquidity

The latest move by the RBA took markets by surprise. Does that mean something is going on with the Aussie that analysts are missing?
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It’s not Chinese demand

The Aussie fell to levels not seen since the pandemic when the global shutdown slowed demand for raw materials. The driving force behind the Australian dollar is that the country is the largest exporter of iron ore in the world. Most of that goes to China, with a substantial amount finding its way to construction projects. Since Chinas construction market is severely impacted, it's natural to suspect that the Australian dollar will be under pressure.

But steel exports have remained relatively consistent so far this year, with Hedland Port reporting around 40Kt of iron ore per month since the start of the year. The ore price hasn't remained consistent, as it's been down over 30% since April of this year. That implies less demand for the Australian dollar to pay for the exports.

RBA constrained by ‘Labor’ budget

But the RBA wasn't worried about ore exports when it raised rates by 25bps on 50bps expectation. It cited the situation in the UK, where the BOE had to intervene in the markets to save pension funds. Although Australia didn't have an unfunded mini-budget, the underlying conditions that caused the markets to be worried are also present in Australia: A lack of liquidity.

Investors are worried about the economic outlook and are unwilling to commit to increased debt. Should the RBA take a more aggressive stance, it might worsen liquidity conditions and weaken the markets. With inflation jumping to 6.1% in the second quarter and the RBA already hesitating in the tightening cycle, it could mean that real rates in the commodity currency continue to fall. With worries about China's economic prospects, the Aussie could be under increasing pressure. Then there is the upcoming budget that the new Labor government is expected to present, likely to include increased spending. That could further complicate the inflation prospect and constrain the RBA's ability to tighten.

Tomorrow Australia reports September job numbers, with the unemployment rate expected to remain at 3.5%, with 25K jobs added compared to 33.5K in August.

Aussie likely to resume trend

AUD/USD appears to be in a bearish pennant consolidation pattern, usually forming after steep declines in price. The narrowing formation defined by the contracting trendlines suggests that traders anticipate the resumption of the primary bearish trend. This is despite the MACD divergence, as the signal lines remain below the zero line and recently reversed down.

If the price breaks below the lower trendline near 0.6250, the round support at 0.6200 lies above the crucial low at 0.6180 (S1). Losing it might pave the way to 0.5780 (S2), the range of the 0.6650-0.6180 leg. However, if the trendline or the 0.6180 low hold firm, the bearish pennant might get invalidated, opening the door to 0.6350 (R1) and 0.6650 (R2).

Key takeaways

The Aussie dollar is under pressure due to iron ore prices falling more than 30% since April. Investors are worried about the economy and inflation, but tighter monetary policy might exaggerate liquidity concerns regardless of whether RBA takes a more aggressive stance, as seen in the UK. This might add more pressure on Aussie while real rates fall. The upcoming budget from the new Labor government is likely to include increased spending, which could further complicate the inflation prospect and constrain the RBA's ability to tighten.