- AUD forced to year-low by interest rate and trade war concerns.

- RBA is becoming less confident in its own outlook for interest rates.

- Trump's $200 billion Chinese tariff package a big negative for the Aussie.

© Filipe Frazao, Adobe Stock

The Australian Dollar fell to a one-year low Tuesday after the Reserve Bank of Australia appeared to downgrade its outlook for domestic interest rates and as financial markets responded to the latest escalation in the so called trade war between the US and China.

Minutes from the latest Reserve Bank of Australia monetary policy meeting omited a key statement saying "members agreed that it was more likely that the next move in the cash rate would be up, rather than down", suggesting at least some of the bank's rate setters are now having doubts about the outlook for Aussie interest rates.

The minutes come at the tail end of a six-month period where Australian inflation has remained stubbornly below the midpoint of the RBA's 1% to 3% target and meagre levels of wage growth have failed to inspire confidence that the central bank will meet its goal of raising inflation to within the upper end of the target band anytime soon.

They also come as concerns over the outlook for the Aussie housing market mount, with prices of high-end residential properties tumbling in Sydney and Melbourne during recent months as auction clearance rates fall and tighter lending standards drive mortgage approval rates lower.

"We think this is an interesting development," says Joanne Masters, an economist at ANZ Research, a division of Australia and New Zealand Banking Group. "On balance, it appears that the RBA has increased uncertainty around how the economy will evolve."

What makes the shift in sentiment contained in the minutes all the more surprising is RBA Governor Lowe last week told the Australian Industry Group that "it is likely that the next move in interest rates will be up, not down".

Masters and the ANZ Research team have been watching developments in the Aussie housing market and the domestic as well as global economies of late saying the deteriorating outlook was behind their decision to donwgrade forecasts for when an initial RBA interest rate rise might come.

"Given the degree of uncertainty around the global economy and how the domestic credit tightening will evolve, we think it not surprising that the Bank may be somewhat less confident about how these risks will play out. We have, ourselves, shifted our expectation of the first rate hike out from May 2019 to August 2019, largely reflecting our views on the housing market," Masters writes, in a note to clients Tuesday.

Interest rates matter for the Australian Dollar as global capital tends to flow to those jurisdictions with higher interest rates because they offer a greater return for investors, in turn pushing up the value of the currency. The Australian Dollar has long benefited from the country's high rates relative to the rest of the world but now that other countries are raising rates and Australia is not budging, the Aussie unit's advantage has faded.

ANZ also forecast a second Aussie rate hike in November 2019, which would take the cash rate up to 2%, to be followed by a period of stability. The RBA has held its interest rate at a record low of 1.5% for what will be two years this August, citing below-target inflation as well as an uninspiring outlook for consumer price pressures and household incomes.

Above: AUD/USD rate shown at weekly intervals.

The AUD/USD rate was quoted 0.55% lower at 0.7361 during the morning session Tuesday, its lowest level since May 2017, while the Pound-to-Aussie rate was 0.03% lower at 1.7910. The Aussie was also lower against all other developed world currencies.

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

"The RBA Minutes dropped a reference to be next move in rates being likely to be upwards, which has added to AUD woes," says Kit Juckes, chief FX strategist at Societe Generale. "AUD/USD 73.50 needs to hold or it will look very much as though the uptrend we've been in since 2016 has been broken."

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China Trade War Keeps Outlook for AUD Muted

President Donald Trump has instructed US trade representatives to begin preparing to impose a 10% tariff on imports of more than $200 billion in Chinese goods, which has already drawn a threat of retaliation from the Chinese Ministry of Commerce and may have far-reaching implications for US inflation, economic growth, interest rates and the Dollar.

It is also a sure-fire negative for the Aussie Dollar, which is highly sensitive to changes in global risk appetite, sentiment toward the Chinese economy and conditions for international trade more generally. China is after all, Australia's largest trade partner, importing a substantial majority of the nation's iron ore output. Iron ore is of course Australia's largest export.

"Heightened global trade war risks have been the main focus during the Asian trading sessions. It has boosted demand for safe haven currencies such as the yen and Swiss franc while high beta currencies such as emerging market and commodity related currencies have come under further selling pressure," says Lee Hardman, a currency analyst at MUFG. "The financial market reaction overnight clearly highlights that market participants are becoming less confident that the US and China will be able to reach an agreement on improving trade regulations."

Hardman and the MUFG team say a further worsening of tensions over international trade would be bad for both the US and Chinese economies, as well as for global growth. This is in line with what other analysts are saying on the subject, with many of them flagging the Australian Dollar as a likely loser.

"While it is likely to take time before the second round of tariffs is imposed, the pure signalling effect is negative for risk appetite. In such an environment, it is the risk assets linked to China that are likely to underperform (as per the decline in AUD overnight) though higher beta FX and in EM in general should remain under a pressure," says Petr Krpata, chief EMEA FX strategist at ING Group.

The trade developments are now tipped by technical analysts to reinforce a trend of decline that has guided Australian Dollar price action for some time now.

"Vulnerability to the U.S-China trade tit-for-tat is keeping the Australian Dollar on the ropes and the charts are pointing to potential for heavier losses. Capped by its weekly Ichimoku cloud since late April, AUD/USD had ranged between the cloud base at 0.7642 and a hammer candle low from early May at 0.7413," says Peter Stoneham, a technical analyst on the Thomson Reuters currency desk.

"Monthly action endorses the bear bias with potential for a bearish engulfing line in June, cancelling out a small May hammer. This is usually a reversal signal but can also highlight the resumption of a trend. A thick and falling monthly cloud is also noted with the base at 0.7748."

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