AUSTRALIAN INTEREST RATES , AUD/USD … WHAT NEXT
The Reserve Bank of Australia lowered the overnight cash rate to an all time low of 2% at the May board meeting. The bank has found itself in a diﬃcult position with the terms of trade (the price of goods we export such as iron ore) falling, but oﬀsetting that has been the property bubble of Sydney and a lesser extent Melbourne. Sydney accounts for 20% of the Australian market so it does bode for concern for the bank. Rather than the government using record low interest rates to issue long term bonds, the cost of borrowing has never been so low, creating jobs through infrastructure projects for the long-term benefits of the nation, politics has got in the way and the general mantra of all debt is bad has meant fiscal policy is running contractionary at a time when growth is slowing and unemployment is rising. This has forced the RBA to take rates lower than they would have otherwise.
China has continued its orderly slowdown from 12+% growth back to ~7% this year. Policy makers are adding stimulus by cutting the reserve requirements banks need to hold (money becomes easier to obtain). Assuming this correction stays orderly, downside shocks for the Australian economy seem less likely from here. That doesn’t mean iron ore will bounce back to $100, but the demand side will be more constant and the iron ore price will be more of a function of the over supply.
In the US the Federal reserve is now waiting for more evidence of growth in the labour market and an uptick in economic activity. Previously forecast to start hiking by the middle of this year, first quarter data was disappointing and the expectation for hikes has been pushed further out. They are expected to hike before the end of the year and when they do it will be slowly.
Can rates in Australia go lower? In a short answer, yes, although the bar to cutting now is significantly higher. There is less foreign risk than previously although Greece is worth watching for contagion eﬀects in Europe. Australian growth will really need to slow, and unemployment will need to start pushing back up through 6.5% for further cuts to be on the table.
With rates likely at the bottom or very close to the bottom for now, and the US delaying the start of hiking until later this a move in AUD/USD into the 60s seems oﬀ the table given the current information on set. Until we get further evidence of the reaction of the Australian economy to the two cuts already delivered this year and the market waiting for the bounce in US data, AUD/USD seems range bound between 7600 and 8100 for the near term.
Sugar traded lower last week with notably lower volumes across every session. The active July contract closed the week on its lows at 12.31. UNICA has upgraded its Brazilian crop numbers to 590 mmt, which is near enough to the maximum amount the current number of operating mills can crush. The tail end of July has been dry, with the harvest numbers expected to be very large.
At current prices, the market is expecting more ethanol to be produced, although it is more than possible both more sugar and ethanol will be produced given the larger crop size. For the switch to ethanol to occur, sugar prices have to remain significantly below ethanol parity and stay there. If this does occur every percentage increase in the blend to ethanol will come at the cost of 750k tonnes of sugar. Whilst this will not solve the surplus (especially given the stocks) it will certainly help relieve some of the pressure.
Another factor to watch is USD/BRL. The higher USD/BRL moves, the lower ethanol parity moves and in turn the lower sugar has to move for the switch to occur. The Brazilian government has helped stimulate demand for ethanol by increasing the mandated blend percentage and changing some taxes. If Petrobras was able to change the regulated gas price this would also aﬀect the price at which sugar would get switched into ethanol.