China’s Economic Stimulus To Support Australia’s Terms Of Trade And Profitability

While the financial market has been recently divided on the Reserve Bank of Australia (RBA)’s monetary policy decision, we maintain our call of no rate cut in the short run, based on a cautiously optimistic outlook on the economy. Firstly, China’s stimulus measures focusing on larger infrastructure investment are anticipated to increase demand for steel and iron ore, which are still very important sectors for Australia notwithstanding its rebalancing towards a more service-oriented economy. Through higher terms of trade, corporate profits are expected to increase and to support the labor market. Secondly, NATIXIS call for a dovish Fed with two cuts expected within a year, should help keep rates low in Australia, containing mortgage payments for Australian households. Nevertheless, the main risk to our scenario is a rate cut by the Fed. Aussie fluctuations tend to be largely driven by the interest rate differential between the RBA and the FED, instead of Australia’s terms of trade. Although the REER depreciated in Q1-19 by 22% from the recent peak, a surge in Aussie triggered a larger interest rate differential could raise the concerns as to whether the RBA will meet its 2% inflation target, pushing for a rate cut. Given our scenario of a 25-bps rate cut by the Fed in December, the RBA is anticipated to make a similar move next February, by lowering the cash rate by 25-bps from the historically low level of 1.50%.