AUD/USD

The tail end of last week was characterised by a sharp rise in risk aversion across most asset classes. The VIX or fear index as it
is known, pushed above the 30% level for the first time since early July of this year. However, what made Friday night’s session
particularly interesting was the fact that equity markets sold off heavily despite better than expected US data (in the main this
reflected the impressive rise in the Chicago PMI). The experience of the past 6 months has been better US data has seen a rally
in risky assets. A number of factors were given to explain Friday’s price action - large asset allocation switching from equities to
bonds and that mutual funds end of financial year was on Friday which would have seen them take profit on long equity market

If these last two factors were the predominant drivers of the sell off, it’s unlikely that they would be repeated given that we
have now entered November (particularly the last point). Moreover, we had further good data released over the weekend with
the China PMI showing the Chinese manufacturing sector had expanded at its fastest pace in 18 months. If we continue to see
data coming out stronger than expected then this may just represent another opportunity to buy the dip in risky assets. While
this may ultimately prove to be correct, for this week we adopt a more cautious stance. Importantly the ECRI leading index
fell for the second consecutive week and this follows an unprecedented 6 month recovery in this index. If concerns about the
durability of the US economic recovery begin to surface this will be not be a good environment for risk assets (AUD, NZD etc).
In Australia the focus will clearly be on the RBA decision. While our economists are forecasting a 50bps hike, the market is
leaning more towards a 25bps move at this stage. On Wed important retail sales and building approvals data are out, which
is likely to show the continued resilience of the domestic economy. On Thurs RBA Governor Stevens’ speaks. As we discussed
above we have a more cautious outlook for the AUD this week and shift our bias to neutral. Offshore there is some important
US data out, with the ISM manufacturing number out tonight followed by the FOMC decision on Thur morning. However, these