Australian Dollar Hurt By RBA, Greenback Looks to NFPs

The Aussie was the biggest loser in overnight trade as muted RBA May commentary along with much worse than expected trade deficit, weighed on the unit throughout Asia and early European trade. The trade deficit widened to -1.6 Billion AUD vs. -1 Billion AUD projected but the steep increase was caused primarily by cyclone activity in the northwest that disrupted iron exports. The bad news in trade may have been a one off event, especially in light of the fact that when adjusted for seasonal variation, the deficit for Q1 of 2007 probably shrunk to 3.31 Billion AUD vs. 3.55 Billion the quarter prior.

The real driver behind Aussie’s plunge may have been the less than hawkish May statement from the RBA. The weak inflation results last month prompted RBA to downgrade its inflation forecast from 2.75% to 2.5%. Furthermore, the central bank projected no serious inflationary impact from the persistent drought affecting the whole continent which has resulted in higher crop prices. The central bank signaled that for now its was content to simply observe the economy without initiating any additional rate hikes. For traders who had banked on another RBA rate hike in June, the tepid tone of the statement served as a disappointment. With Aussie trading at 17 year highs fueled in large part by some of the highest interest rates in the industrialized world, the RBA appears to be cautious about stoking more carry trade demand by hiking rates further. In short, the Australian central bank let the market know that it is unwilling to raise rates higher unless it is absolutely compelled to do so by spiraling price data and as a result, Aussie longs were liquidated throughout the night.

In Europe today, the economic news was essentially in line, although the services PMI data did print a bit soft. The index registered a reading of 57 vs. 57.6 as Italian and French data slipped. All of the components with the exception of employment were higher, but the pullback in employment suggests that the higher euro may be exerting some drag on future growth. At the very least, tonight’s data indicates that expansion in the 13 member region may have hit a short term peak as the index dropped to it lowest level in 6 months. The pair hardly reacted to the news however, as the EURUSD continued to trade in a very narrow 1.3545-1.3560 range ahead of the key event this week – US Non-Farm Payrolls. With market sentiment towards the US report already sour the risks for the dollar lie to the upside, unless the number prints extraordinarily weak at less that 60K jobs. Furthermore, as always the prior month revisions will be as important as the headline itself and the prices may well whipsaw in the first few minutes post release so caution and patience are advised.