AUD/JPY Poised For Big Shift?

Battle of The Weakest

Over the last three months, AUD/JPY has appreciated considerably with price printing one-year highs above 87 in December as JPY weakness was amplified in the wake of the US election and FOMC rate hike. However, JPY and AUD were the two worst performing G10 currencies over that period which limited both the upside and the extent of the pullback when the US finally lost upside momentum.

As high beta expressions on USD direction, it is likely that AUD and JPY will retain a substantial correlation in the short term, capping the scope for a breakout. However, AUD/JPY still remains one of the more reliable barometers for risk. If there was to be a sustained correction in US equities, then this would likely lead to a break in the 84 level support. Arguably, following the sharp post-election gains, a correction could be in store.

Monetary policy is unlikely to return to markets’ main focus for a while as global risk appetite and the trade environment take center stage. There are risks in the short term of a fall back to 84 or as deep as 82 if we see a significant risk-off event. This could provide a good buying opportunity as Yen weakness materializes again once conditions stabilize and risk appetite improves over the year.

RBA Outlook

The RBA cash rate currently sits at 1.5%, which their RBA maintained at their recent December meeting whilst giving a fairly neutral statement.The meeting minutes showed that the RBA considered “the policy decisions made throughout the easing phase since 2011” including the “effect of lower interest rates on asset prices and the decisions by households to borrow, particularly given the already high levels of household debt”.

These comments have further strengthened the view that in the RBA’s eyes, the barrier to further rate cuts has been heightened. Currently, the market is pricing only a very small chance of a rate cut by June 2017, at 5% – 10%, and only 35% – 40% by year end. The skew towards favouring higher rates has clearly been impacted by the rise in global yields following the US election.