RBA leaves policy unchanged 

But AUD remains weak on China news

EUR remains vulnerable to further reductions in ECB rate hike expectations

We still see downside risks for EUR/JPY and USD/JPY

It’s a quiet week for data and events, so even through the RBA meeting on Tuesday was universally expected to produce no change in policy, it is probably the highlight of the day. The AUD is something of a focus at the moment among the G10 currencies, as global risk sentiment is currently very dependent on China news, and the AUD is both the most responsive currency to moves in global risk appetite and the most influenced by news from China, particularly in terms of expectations of Chinese growth. The AUD did manage a modest gain on Monday on the news that Country Garden had agreed an extension on its domestic bond payment, but continues to lag behind the recent gains in Chinese equities. This is in part because the rise in the equity market is seen as partially due to government support rather than a genuine improvement in expectations of Chinese growth. It would be a major surprise if the RBA changed policy at this meeting, but there will be sensitivity to any indications of potential future moves. We have an almost copy and paste RBA statement as expected with RBA remaining inflation sensitive in pulling the trigger. The Aussie did not react to the release but has been dragged by other Chinese headlines.

As it stands, the AUD curve suggests policy is likely to be broadly unchanged for the next year, with a modest risk of one more rate hike and declining rates expected from a year out. We doubt the RBA decision will disturb this expectation, so the AUD will likely continue to focus on China, with expectations around whether Country Garden pays the upcoming USD bond coupons potentially the driving factor. Other Chinese property companies have missed USD bond payments already, so it would not be a major surprise if Country Garden did the same. The authorities are only really concerned about them maintaining CNY based payments. Nevertheless, if expectations rise that they will miss USD bond payments, the better risk tone seen on Monday may well reverse.

The Country Garden story, and possibly some positive sentiment around Ukrainian military progress at the weekend, helped to maintain a mildly risk positive tone in Europe on Monday. However, the run of European data continues to be quite weak. Another dip in the Sentix sentiment index for September on Monday followed the soft final manufacturing PMIs last week. The final services PMIs on Tuesday  didn't have much impact, as they were not much revised, but should be a reminder of the softness of the recent European data. We continue to see downside risks for the EUR as the market prices out the risks of a rate hike this year. The expectation of a September move has already been cut to around a 25% chance, but there is scope for the 50% chance of a hike priced in this year to be completely eliminated. This suggests EUR/USD has downside risks through the 1.0750 support area, with the potential for unwinding of long held long EUR positions.

However, we still prefer EUR/JPY downside to EUR/USD, partly because we see the rise in US yields after Friday’s employment report as somewhat unjustified by the data, and likely partly due to pre-holiday position squaring. Even with the rise in US yields, USD/JPY above 146 looks overextended, and we see downside scope for both EUR/JPY and USD/JPY from here.