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The Australian Dollar: Still Pricing-in RBA Cuts but Federal Reserve Guidance Could Ease Pain

© Greg Brave, Adobe Stock

- AUD draws support from crucial jobs data and Fed retreat

- Unemployment falls to 4.9%, but details disappoint economists

- Citi says no rate cuts in 2019 but market still prices RBA easing

The Australian Dollar was supported on Thursday by jobs data that appeared to show the Aussie labour market in good health and by Federal Reserve hints that it will not raise U.S. interest rates this year, but financial markets are still concerned the Reserve Bank of Australia (RBA) could cut its rate this year. 

Australia's unemployment rate fell to 4.9% in February, from 5.0% previously, but economists say that's only because some people gave up looking for work that month. The participation rate declined by 10 basis points to 65.6%. 

The Aussie economy created 4.6k jobs in February, disappointing a market that was looking for a 14k increase, although jobs rose only because of an increase in part-time employment. Full-time jobs numbers fell in February.

As a result, the data was not nearly as positive for the Aussie economic and interest rate outlooks as the headline numbers had suggested. But it really bad either, so economists are divided over what it might mean for the Reserve Bank of Australia policy outlook. 

"We have said it for some time and coupled with further weakening in the leading indicators of employment and activity, we continue to think that this is as good as it gets for the AU labour market.  A more sustained moderation is likely from mid-year," says Elsa Lignos, head of FX strategy at RBC Capital Markets. 

RBA Governor Philip Lowe said in February that if there were to be a sustained increase in the unemployment rate and a lack of further progress towards the inflation objective, lower interest rates might be appropriate at some point.  

Since then financial markets have been betting heavily the RBA will cut rates at least once before the year is out and most domestic lenders have adapted their forecasts to imply either one or two interest rate cuts for 2019, which could take the cash rate down from 1.5%, to as little as 1%. 

Analysts at Citi, one of the worlds largest lenders and a dominant force in currency trading, said Thursday that the RBA is "unlikely" to cut rates this year. It said that risks to the economy are "elevated but contained". 

But Westpac, one of Australia's largest banks, has a different view. 

“What we can say is that it does appear that the momentum in employment has slowed. As such, there is nothing in this release to make us change our view that employment growth will take a breather through the first half of 2019 leading to a lift in unemployment,” says Justin Smirk, an economist at Westpac. “While we are cautious about interpreting too much from the January/February releases, we see nothing in them that makes us nervous about our forecast.”

Westpac's forecast is that RBA officials will take the plunge and cut interest rates twice this year, with the first cut to 1.25% coming in July and another cut, to 1%, following in November.

The market-implied cash rate for December 03, 2019 was just 1.13% on Thursday, which is far below the current 1.5% cash rate and implies that markets are close to betting the house on two full rate cuts. 

"For Australia, iron ore and coal prices remain key. Over the past year, both markets have seen significant supply disruptions and a seeming unwillingness (or inability) of producers to quickly offset the production loss. Coupled with ongoing structural reform (which preferences high-quality inputs) and strengthening construction-related demand for steel in China, impaired supply has resulted in elevated price levels for both iron ore and metallurgical coal," says Elliot Clarke, an economist at Westpac, in an earlioer note. 

Westpac says the AUD/USD rate will meander between the 0.68 and 0.70 levels for much of this year, which is close to its current level, despite the dire interest rate outlook. This due to upward pressure on prices of some key exports which, technically, improves the fundamental value of the Aussie Dollar.

The AUD/USD rate was -0.03% lower at 0.7130 Thursday but is up 1.1% for 2019. The Pound-to-Australian-Dollar rate was down -0.58% at 1.8405 but has risen 1.6% this year.

The Australian Dollar and other currencies also drew support overnight, as well as into the Thursday session, from an earlier change in Federal Reserve guidance for its own interest rate policy through the rest of the year.

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