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- RBA holds rates, but broadens watch list of triggers for more cuts.

- Now looks at broader array of indicators including slowing growth.

- Market looks for third cut in October and another early next year.

- Westpac says AUD/USD downside will be limited by Fed rate cuts.

- But Societe Generale says trade war, CNH weakness to hurt AUD.

The Australian Dollar rose to the top of the G10 league table Tuesday after the Reserve Bank of Australia (RBA) neglected to provide investors fresh impetus for selling the currency, which is tipped by analysts at Westpac to remain supported around current levels.

Australia's Dollar was on its front foot after the Reserve Bank kept the cash rate on hold at 1% and cheered a modest improvement in some parts of the housing market, although gains may have had more to do with the country having recorded its first current account surplus since 1975. The performance is notable because it comes in a session where the Chinese Renminbi has fallen to new lows and the U.S. Dollar has been buoyed by fears for the global economy, which would typically be bad for the commodity-backed Aussie.

Last quarter saw Australia swing from a -$1.1 bn deficit to a $5.9 bn surplus due to export-driven increases in the trade surplus and an improvement in the international investment position. The current account measures the flow of funds into and out of a country as well as changes in liabilities to the rest of the world. In the process, it provides not only a snapshot of real world supply and demand of a currency but also a gauge of the extent to which a country and its currency are exposed to the changing sentiments of international investors.

"The key driver of the improved performance is sharply higher export earnings largely centred on rising commodity prices. Notable, was the iron ore price spike following the tailings dam disaster in Brazil. The iron ore price has since pulled-back in August," says Andrew Hanlan at Westpac. "Net exports made a sizeable positive contribution to growth in Q2, +0.6ppts."

Above: Australian Dollar performance Vs G10 rivals Tuesday. Source: Pound Sterling Live.

Reserve Bank of Australia Governor Philip Lowe said Tuesday the board will monitor developments "including in the labour market" closely over the coming months and adjust its policy settings if necessary. Previously, the bank said only that it would "monitor developments in the labour market closely", suggesting it will now take its lead from a broader array of indicators.

"A subtle change, but suggesting that the Bank will be looking at more than just the employment data when it decides the fate of the cash rate at its next meeting," says David Plank, head of Australian economics at ANZ. "On the domestic outlook the RBA is perhaps a little less certain than in August, removing specific numerical reference to its forecasts."

The RBA's shift comes at a time when it appears to be losing confidence in its own forecasts for the economy, and just ahead of publication of second-quarter GDP figures. The bank said Tuesday that it expects GDP growth to "return to trend over the next couple of years", when its actual forecasts point to an expansion of 2.5% in 2019, 2.75% in 2020 and 3% in 2021.

Above: AUD/USD rate shown at hourly intervals, alongside GBP/AUD rate (aqua green, left axis).

The 2019 GDP projection is a significant downgrade from the "a little over three percent" the RBA had tipped in the first quarter and anything less than 'trend' rates of growth would be insufficient for generating the still-elusive inflation pressures the RBA has been seeking for a number of years now.

Furthermore, with the bank no longer focused solely on the jobs market, it might now be persuaded to cut again if growth data disappoints and GDP figures for the second quarter are due out at 02:30 London time on Wednesday.

"Growth around trend is unlikely to be sufficient to push inflation back into the target range on a sustained basis. So it seems reasonable to assume that in the absence of an upward growth surprise the RBA thinks more than 50bp of easing (or its equivalent) will eventually be required," says ANZ's Plank.

The RBA cut the cash rate by 25 basis in both June and July, leaving it at 1%, in an effort to lift inflation by stimulating the economy with lower borrowing costs. Changes in rates are normally only made in response to movements in inflation, which is sensitive to GDP growth, but impact currencies because capital flows tend to seek out the most advantageous or improving returns.

Minutes of the RBA's previous meeting suggested last week the bank would like to see an “accumulation of additional evidence” that more stimulus is necessary before acting again, leading markets to foresee a third 2019 cut coming in October. The bank didn't elaborate on what it meant by the term an "accumulation of additional evidence" so it's unclear whether a poor GDP report on Wednesday, or Tuesday's disappointing retail sales figures from July, would be enough to force its hand.

"It is likely that tomorrow’s GDP report for the June quarter will show the economy had less momentum than had been expected by the RBA at the time of the August meeting," says Bill Evans, chief economist at Westpac. "If Westpac’s forecast for GDP growth in the June quarter of 0.5% proves to be correct, then the RBA is likely to need to revise down its growth forecast of 2½ per cent for 2019 and reasonably review the 2¾ per cent forecast for 2020."

Above: AUD/USD at daily intervals, alongside difference between AU and U.S. 2-year bond yields.

Evans' and the Westpac team forecast the RBA will cut the cash rate to a new record low of 0.75% in October but they say the impact on the Australian Dollar will be tempered by offsetting and earlier actions from the Federal Reserve, which is also expected to cut U.S. rates in order to insure the economy against a potential downturn resulting from the trade war with China. And those U.S. rate cuts will boost the attractiveness of Aussie bonds and their Dollar in the eyes of investors, which Westpac says will limit the downside for the antipodean Dollar.

Westpac also says the Aussie will be supported in the weeks ahead by dividends paid by mining companies to Australian shareholders by mining companies, which requires U.S. Dollar profits to be converted into Aussie Dollars. However, and despite the house view being that the downside from here is relatively limited, Westpac also says any Aussie Dollar rallies seen over the weeks will be capped by levels that are not far off.

"Markets will continue to price another RBA rate cut before year end but even before the next RBA meeting we should see the Fed lower rates again. Indeed yield spreads have moved back in AUD’s favour over the past month as trade wars are judged to have greater implications for the Fed than the RBA," says Sean Callow, a strategist at Westpac. "AUD/USD should continue to find buyers on dips under 0.6700. But the global mood seems too risk-averse for rallies to extend beyond the 0.6780/90 area."

Westpac may be looking for more range-bound trading by the Aussie over the coming months but other analysts see potential for weakness in Chinese Renminbi exchange rates to push the antipodean unit lower from here. That might be particularly likely if progress in U.S. and Chinese efforts to de-escalate the trade war between the two countries come to nothing. The Aussie has a strong positive correlation with the Renminbi.

Above: The Australian Dollar and Chinese Renminbi share a strong positive correlation.

President Donald Trump went ahead Sunday with a new 15% tariff on another $112 bn of goods imported from China each year, which takes the total value of Chinese exports now covered by punitive levies above $360 bn, although there's still a further $190 bn worth of tariffs scheduled to take effect on December 15. China has retaliated with a tariff of its own on around $75 bn of imports from the U.S., although its capacity to respond is constrained by the fact it has a significant trade surplus with the U.S.

"The correlation of AUD, and NZD, with the USD/CNY rate is striking at present and if the yuan remains under pressure, both AUD and NZD will fall against the US dollar the yen and the Canadian dollar," says Kit Juckes, chief FX strategist at Societe Generale.

The U.S. and China have been warring with tariffs and other policy tools over the latter's "unfair" trading practices since the first quarter of 2018 and with the White House facing an election year in 2020, it's under pressure to secure a victory and cannot afford to lose face in the conflict. Global trade, not to mention economic growth, has already fallen as a result of the uncertainty thrown up by the conflict but many now anticipate further weakness ahead.

And Australia's Dollar has been wounded by the tariff fight because it has a close correlation with China's Renminbi and is to a large extent underwritten by commodity exports to the world's second largest economy, prices of which risk being dented by the souring outlook for global growth.

The U.S. economy has so-far been resilient in the face of slowing global growth but the bond market is now pointing to trouble ahead and the Federal Reserve, while under fire from President Trump, is now expected by the market to cut interest rates multiple times in the quarters ahead.

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