The central bank does not intend to raise rates until the Australian economy has returned to full employment

The decision of the Reserve Bank to keep the base interest rate at 1.5%, coupled with the moderate pigeon rhetoric of the regulator was a cold shower on the hot heads of the Australian dollar fans. The day before, an improvement in global appetite for risk, strong statistics for April retail sales (+0.4% with a forecast of +0.2% m/m), positive GDP expectations for the first quarter and optimism of the OECD over the state of the Australian economy and the prospects for the start of the normalization of the monetary policy by the RBA pushed the quotations of the AUD/USD to 1.5-month highs. The show wasn't long.

The Organization for Economic Cooperation and Development predicts that the central bank will start raising the cash rate at the end of 2018 amid the acceleration of average wages and inflation. GDP will grow by 2.9% and 3%, unemployment will drop to 5.4% and 5.3% in 2018-2019, and the growth of the economy will be facilitated by the bullish commodity market conditions and strong external demand. The fact that the futures market did not expect a tightening of the monetary policy from the RBA before the second half of 2019, and the the OECD was full of optimism, played into the hands of the buyers of the Australian dollar.

In fact, the pertaining tension in trade relations between the US and China, political uncertainty in the euro area and the rising cost of borrowing in the US, coupled with sluggish wages, inflation, and rising unemployment in Australia, lowered the chances of the first rate increase by the reserve bank since 2016, which affected the AUD/USD dynamics. The pair showed increased sensitivity to the events connected with the developing markets, and it had reasons.

Dynamics of MSCI EM and future values ​​of the cash rate

Source: Bloomberg.

Over the past five years, the yield of 10-year Australian bonds averaged 69 bp higher than American counterparts, which allowed carry traders to use the Aussie as a lucrative currency. The divergence in the monetary policy of the RBA and the Fed led to a negative differential (-15 bp), which forces the difference players to look for other instruments and switch to the currencies of developing countries. This deprives the AUD/USD bulls of an important trump card.

Dynamics of yields of bonds of Australia and the USA
 

Source: Bloomberg.

According to Morgan Stanley, the Fed will raise the federal funds rate to 2.5% within the next 12 months, while the RBA will maintain its present course aimed at the retention of the cash rate. This circumstance allows the bank to predict the continuation of the south-bound journey of the analyzed pair.

The Reserve Bank made it clear that it does not intend to tighten the monetary policy until unemployment is confidently moving to 5% (full employment), and inflation - to the middle of the targeted range of 2-3%. The Aussie will continue to stay under the sword of Damocles in the form of the risks of global trade war, which will simultaneously slow down the global economy and worsen the global appetite for risk. In this regard, the potential for correction of the AUD/USD looks limited and it makes sense for investors to sell the pair upon the rebound from resistance at 0.769 and 0.777.

RBA has turned on cold shower for the Aussie

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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