CBA: If you think a credit rating downgrade will weaken the Australian dollar, think again

On Thursday Standard and Poor’s placed Australia’s AAA sovereign credit rating on watch “negative”, implying that there is now a one-in-three chance that it will be downgraded within the next two years without remedial action to address the agencies concerns.

As soon as the announcement hit, the Aussie tumbled by 1% in a matter of seconds before rebounding in the hours following.

The 5-minute tick chart below, courtesy of Thomson Reuters, shows the wild price action seen following the announcement.

The rebound, something that eventually saw the AUD/USD rise back to the levels it was trading at prior to the announcement, has some people scratching their heads.

Why, if Australia could potentially lose its credit rating, would investors want to buy the Aussie?

To Joseph Capurso, senior currency strategist at the Commonwealth Bank, there is a simple explanation to rapid recovery: there are more important factors that drive currency movements rather than credit ratings.

“We do not believe S&P’s change in view will be a trigger for a sustained down-leg in AUD/USD. After all, the Australian government’s rating has not been cut, merely the risk of a cut to the rating in the next two years has increased to one in three,” says Capurso.

“Most importantly, credit ratings are not a fundamental driver of AUD. Commodity prices, current account balances, and interest rate differentials are much more important drivers of AUD.

“Because the change in the outlook for the Australian government’s credit rating will not change any of these fundamental drivers of AUD we see no reason to change our medium term AUD forecasts,” he adds.

Capurso sees the AUD/USD finishing the year at 73 cents. In a recent poll conducted by Thomson Reuters, the median forecast is for the Aussie to close out 2016 buying 71.5 cents.

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