Only a few weeks ago we were talking about the Aussie and the Kiwi acting like safe havens. That talk was premature. After a massive rout in both currencies last week where do we stand now? The move in the Aussie was fuelled by a general sell-off in risky assets and also a large decline in interest rate expectations. Whereas markets had expected a further rate rise by the end of this year, now the markets are pricing in the chance of a rate cut.

The decline in Australian 1-year interest rate swaps (a good measure of short-term rate expectations) has mirrored the decline in the Aussie as you can see in the chart below.

Aussie 1-year rate swap (white line) and AUDUSD (orange line)

Going forward we believe the markets will remain skittish as investors try to size up the chance of a double-dip recession. This will be key for Aussie rate expectations. Although Australia has low debt and unemployment levels its growth is highly leveraged to the global economy. If global growth falters this will hurt Australia since its natural resources sector is a major driver of growth.

Tomorrow's RBA minutes will be interesting, but since the meeting took place before the latest outbreak of risk aversion we think the RBA will have become markedly more cautious on the outlook for rates. Thus the September 6th RBA meeting will be crucial to determine the outlook for the Aussie.

The technical picture for the Aussie is fairly mixed. It may do well against the Swissie and the yen, as these currencies come under pressure due to intervention risk. However, its fate remains tied to investor risk appetite. If this recovers in the short-term then we expect EURAUD to come back under pressure. The enormous jump higher in EURAUD is being eroded as we start a new week. It is currently below its pivot point at 1.3775, which suggests there may be further declines. Support lies at 1.3715 then at 1.3670.

However, in the current environment we would not look for a definite change in trend and are still cautious on risky FX in the medium-term. Any respite for risky assets could be short-lived, so investors must be nimble.

EURAUD hourly chart. After a big move last week it is currently treading water. However, if we get a recovery in risk appetite in the short-term this pair may come under pressure.


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Kathleen Brooks| Research Director UK EMEA |

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