The Australian Dollar: Strong Jobs Data Not Enough to Prevent RBA Rate Cuts

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- AUD slides despite jobs report, after Westpac forecasts RBA rate cuts.

- AUD sees strong full-time jobs growth in January, jobless rate holds 5%.

- But Westpac says RBA to cut twice in 2019 as the economy is in trouble.

The Australian Dollar collapsed during the overnight session into Thursday after a strong labour market report proved insuffficient in preventing leading economists from warning the Reserve Bank of Australia (RBA) will likely cut interest rates twice this year.

Australia's economy created 39.1k new jobs during January, up from a downwardly-revised 16.8k previously, which was far ahead of the consensus for an increase of 15.2k. The unemployment rate was unchanged at 5%, in line with expectations. 

The details underlying the data were strong too, with 65.4 k new full-time jobs created during the month, which more than offset a *-26.3k fall in the number of part-time employees during the month. That's about as favourable as an Aussie jobs report can get. 

"The fact that full‑time jobs growth (+65.4k) drove net employment growth and the fact that the under‑employment rate fell from 8.3% to 8.1% signals it is a strong labour market report," says Richard Grace, head of currency strategy at Commonwealth Bank of Australia. "RBA Governor Lowe emphasised the importance of the labour market following the RBA’s shift towards a neutral monetary policy stance."  

Above: Australian jobs growth rates. Source: Commonwealth Bank of Australia.

Currency markets carea about the data because falling unemployment leads to faster wage growth, greater demand and higher inflation within an economy, which is important for the interest rate outlook.

Changes in rates are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on capital flows and their allure for short-term speculators.

The Reserve Bank of Australia said in February that a sustained increase in unemployment would be enough to force policymakers into an interest rate cut. The bank also downgraded its growth forecasts and warned about risks posed to Australia by a weak global economy.

For these reasons the January's jobs data was watched closely by the market more so than it normally would be. But the strong report was not enough to prevent one of Australia's leading economists from warning that interest rate cuts are coming. 

"Westpac now expects the Reserve Bank to cut the cash rate by 25bps in both August and November this year," says Bill Evans, chief economist at Westpac. "Momentum in 2018 slowed dramatically through the year. The annualised growth rate in the first half was 4% whereas in the second half we estimate that the pace slowed to 1.5%."

Evans says the RBA's new lower growth forecasts are still too high given the extent to which the economic expansion slowed in Australia last year. Taking GDP growth back up from an annualised pace of 1.5% to around 3% is too much to ask at a time when the Chinese and global economies are slowing. 

He also says Australia's slowing GDP growth, faltering housing market and weak consumer spending are likely to persist and will mean the RBA's forecast of a 4.7% 2020 unemployment rate is far too ambitious.

The bank will slowly but surely realise this during the first half of 2019, which will prompt it to cut the cash rate in August and then again in November, taking Australia's main interest rate down to a new record low of 1%. 

Above: AUD/USD rate shown at daily intervals.

The AUD/USD rate was quoted -0.67% lower at 0.7119 Thursday and is now up just 0.97% for 2019 after chopping back an earlier 2.7% gain last week.

"The net impact of these forecast changes is for a further 25bp deterioration in the overnight cash rate differential. That puts downside risks to our current target of USD 0.68 for the AUD in the second half of 2019 particularly if the expected cuts from the Reserve Bank are ineffective," Evans warns. 

The Pound-to-Australian-Dollar rate was 0.83% higher at 1.8350 and has now risen 1.4% for the year-to-date. The Aussie was lower against all G10 currencies Thursday.

Above: Pound-to-Australian-Dollar rate shown at daily intervals.

Evans is also now forecasting only one rate hike from the Federal Reserve this year, which lessens the likely pressure to be felt by the Aussie, although bilateral interest rate and bond yield differentials are still seen turning further against the Antipodean unit.  

These forecasts, and other events, put a significant dent into the Australian Dollar Thursday. But that price action comes at a time when markets are growing ever more optimistic that a deal to end the trade war between the U.S. and China is in the pipeline.

President Donald Trump continues to express confidence a deal can be struck before the March 01 deadline that will see tariffs on some imports from China more than double to 25% unless the White House extends the negotiating window or a deal is struck before. 

"Trump told reporters US-China talks are “very complex” but are “going very well” reinforcing the idea that even if Lighthizer tells him China has not given enough ground on state subsidies and forced technology transfers, he will overrule his USTR and strike a ‘deal’ all the same," says Elsa Lignos, head of FX strategy at RBC Capital Markets.

This comes after Bloomberg News reported Tuesday that Trump is demanding China commit to keeping the Renmimbi stable, as part of any deal to end the tariff fight between the world's two largest economies.

That is positive for the Australian Dollar because it is closely correlated with China's currency. The correlation exists because the Antipodean unit is substantially underwritten by a mammoth bilateral commodity trade with China.

Preventing China from devaluing its currency could neutralise a notable headwind from the Australian Dollar over the long term, assuming Trump is succesful, although jobs and umployment figures for the January month will be the key focus of Antipodean traders early in Thursday's session.   

"For China, this looks to be consistent with current FX policy. For the US, the aim of this memorandum is probably an attempt to limit Beijing’s room to depreciate its way out of a slowdown. This reduces the risk of a CNY devaluation and should help Asia FX ," says Chris Turner, head of currency strategy at ING Group

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