Counterintuitive Forex reaction to Aussie budget | …and how we might play it

Australian monetary authorities are determined to turn their fiscal deficit into a surplus, and they are not averse to a marked degree of relative austerity in order to do so. That is the clear message contained in the provisions of the annual budget that was announced yesterday. Increased taxes, including a so-called deficit tax, and spending cuts were the order of the day. And this is on top of an expected severe reduction in the contribution that can be made by the mining sector to the economy, as a result of a decrease in Chinese economic activity and a fall in the price of Iron Ore and other core commodities.

The Aussie dollar reacted well to the budget. We believe that this is as a result of institutions entering the market that have a longer term perspective than most. It is reasonable to believe that, in time, the measures being taken will be a positive for the economy, and it is a responsible government that will take the long term, temporarily unpopular measures that are seen to be needed.

So far so good. But what of the day-to-day Forex trading community, of which we are a part? Is it possible that when those participants with a longer time horizon than most have taken their fill of Aussie dollars, the rest will start to focus on the fact that the austerity in the budget will, almost inevitably, push out in time the raising of interest rates and result in subdued inflation and a reduction in economic growth, all of which are negatives for the currency? We think that is a distinct possibility. Then consider that a reduction in the strength of the Aussie is exactly what the government wants in order to offset the more depressing effects of its budget policy.

And how we might play it

Today will see the publication of two reports in the UK that can be expected to make today UK day in the Forex markets: The unemployment rate and the BOE quarterly inflation report. The bank’s Monetary Policy Committee (MPC) held off raising rates at its last meeting, precisely so that it could monitor both unemployment and inflation in order to better decide what to do in this area. The market seems to have priced in an earlier rather than a later raising of rates, so any disappointment in either inflation (lower than expected) or employment figures (higher employment rate than expected) will have a negative affect on Sterling later today.

However, the UK economy is still strong, and getting stronger. Any pullback in the pound against counterparts will be nothing more than a correction in a well established upward trend. One way to play the expected resumption of the upward trend is against the Aussie dollar, as discussed above.

Right now the GBPAUD is hitting its 200 Day Simple Moving Average (SMA). The question for us is: how far below it will it go before it resumes its upward trajectory?