Aussie resilience unlikely to last

AUD has displayed remarkable resilience to the RMB depreciation given its significant export exposure to China. Positioning at least partly explains this, as well as the RBA moving to a more neutral stance on the policy rate and FX.

Another key factor behind the resilience is despite the pessimism around China and commodities, steel prices have actually rebounded over this period. Steel prices represent a better, more stable, metric of China's commodity demand (especially for iron ore and coal) as it is less influenced by the impact of inventory swings at Chinese ports and mills. This partly explains the surprising resilience of the AUD following the China FX fixing move but is unlikely to be sustainable given the downside risks to China growth. 

"We believe the AUD has not yet factored in the new regime for China FX, which should eventually pressure the currencies of its main trade partners (CNY depreciation and the AUD 11 February 2015)", says BofA Merrill Lynch

The RBA appears relatively comfortable with rates where they are. It is expected that in the short term it will continue to scan the environment for any downside risks, but the hurdle for another cut is high. There has certainly been no catalyst in the data flow over the past month which would prompt the RBA to consider cutting rates at the moment. And the base case remains that the Bank's comfort in keeping rates unchanged should gradually grow over time, allowing it to leave rates on hold for an extended period. Drivers other than rate expectations, such as weak commodity export prices and a decline in capital inflows to the resource sector will still keep downward pressure on AUD.