The Australian Dollar Gains as Renminbi Jitters Ease but a Moment of Reckoning Now Awaits 

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- AUD gains as market fears over CNY depreciation begin to ease. 

- But RBA statement a potential bannana skin for AUD overnight. 

- Commerzbank chart analyst suggests AUD/USD at inflection point.

- And moment of reckoning awaits with August U.S. tariff decision.

- Bank of America says AUD most vulnerable to new China tariffs.

The Australian Dollar topped the G10 league table Thursday as financial market fears over the outlook for the Renminbi and state of U.S.-China relations ebbed, but the Antipodean currency is at an inflection point and approaching a moment of reckoning that could either mark recovery or prompt severe losses. 

Reserve Bank of Australia (RBA) Governor Philip Lowe will update lawmakers on the outlook for the economy and interest rates at 00:30 London time, before releasing the bank's latest statement on monetary policy at 02:30. Both events will provide the market more colour on Tuesday's interest rate decision. 

The RBA left its cash rate unchanged at 1% this week after cutting it on two consecutive occasions in recent months and said only that it'll act again if the outlook for the economy warrants it. That led markets to briefly entertain the idea it might wait a while before slashing Aussie borrowing costs a third time. 

Since then the Reserve Bank of New Zealand (RBNZ) has pledged to "leave no powder dry" in its quest to reflate the Kiwi economy, a comment that came after the bank blindsided the market with an interest rate cut that was much larger than many had anticipated. As a result, markets are mindful the RBA might want to keep pace with the Kiwi central bank and that it could signal that in the early hours of Friday, potentially hurting the Australian Dollar. 

"The Q&A sessions between RBA Governor Lowe and the members of the House Economic Committee will likely generate more AUD volatility. The Committee may want to quiz the Governor on topics like the lower bound for interest rates, how might an Aussie‑style QE program work and what preconditions would deliver such a program," says Elias Haddad at Commonwealth Bank of Australia. "The Governor’s views on unconventional monetary policy in Australia risk undermining AUD later today."

Above: AUD/USD rate (right axis) shown at hourly intervals alongside NZD/USD (orange line, left axis).

If the Aussie makes it through the night without being dealt a blow by Lowe and the RBA, it could mean the Antipodean unit is poised to avoid steep descent back down to its 2008 low against the U.S. Dollar because Commerzbank said Thursday that a rise back above 0.6832 would alleviate any immediate downside pressure on the exchange rate. The AUD/USD rate was trading at 0.6812 around the London close. 

"AUD/USD has recently eroded the .6738 January 2019 low and .6720, the 2016-2019 support line (connects the lows) BUT has not CLOSED below here. This looks to have been a spike low and we would allow for some consolidation/correction near term," says Karen Jones, head of technical analysis at Commerzbank. 

Jones told clients previously on Wednesday that a decline below 0.6720 earlier this week had all but removed one of the last technical support levels stood between the AUD/USD rate and its 2008 financial crisis low of 0.6020, with the decline indicating ongoing weakness that would draw the market down toward that level. But the original move seen on the charts was quickly faded, leaving the Aussie at an inflection point.

If Friday's RBA statement reinforces the earlier suggestion that the RBA might wait a few months before cutting rates again, then the Aussie might find itself with the momentum needed in order to regain the 0.6832 level that would alleviate downward pressures. But if the RBA indicates that it might follow in the footsteps of the RBNZ sooner rather than later the Aussie may then have the downward momentum it needs to truly erode the 0.672 threshold that would set it up for deeper declines. 

"The AUD has reached fresh decade lows as markets anticipate potential "catch up" by the RBA, especially in a bad scenario. Under a positive scenario, a record trade surplus and strong terms of trade, could rapidly bolster AUD," says David Woo, a strategist at Bank of America. "Our scenario analysis implies the AUD has the scope for the largest moves around a "make or break" moment leading up to 1 September, when US tariffs on China are set to escalate."  

Above: AUD/USD rate shown at monthly intervals. Price on the right axis. 

President Donald Trump has said China's remaining $300 bn of annual exports to the U.S. would be subject to a 10% tariff from September 01, although some analysts say this will rise to 25% sooner or later and markets are now adjusting to the idea that hostilities between the world's two largest economies go on for a while. China's other $250 bn of annual trade is already under a 25% levy, which Trump has threatened multiple times to impose on all U.S. imports from China. 

The 18-month long trade war between the world's two largest economies has hurt business confidence and investment everywhere. The global economy has been slowing noticeably since the second half of 2018, and the Aussie has been among the chief casualties of tariff fight because of Australia's extensive trade relationship with China and the heavy weighting toward commodities like iron ore, coal and gas in the composition of the economy. 

All of those ailments are tipped to get worse if the new tariffs go into effect next month and Bank of America says the Aussie will again be the big casualty in such a scenario, but the American investment titan also says the Aussie would benefit notably if a deal averting the tariffs is reached before month-end. As a result, Woo has advocated that Bank of America clients use a complex currency options structure to bet on the Aussie rather than anything else. 

Woo's idea has been to design a structure that will pay investors a return regardless of what happens with the tariffs, so long as the bank's estimates are correct. In other words, and much like with everybody else, Bank of America is unsure which way things will go later this month or what the fate of the Australian Dollar will be on the other side of September 01. For this reason, the bank's analysts are looking at strategies that might pay off regardless. 

Above: Bank of America estimates of currency sensitivities to various trade war scenarios.

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