Reserve Bank of Australia vs Federal Reserve: Battle of the Central Bankers

Reserve Bank of Australia vs Federal Reserve: Battle of the Central Bankers

A by-product of Australia’s and the US’s growth forecasts, the divergence in monetary policy has become another major driver for AUDUSD strength. The Reserve Bank of Australia (RBA) last raised its overnight lending rate in August by 25 basis points to an 11 year high of 6.50 percent. RBA Governor Glenn Stevens made it abundantly clear that he sees no reason to relax monetary policy, even with the recent ripple in the global credit market. The central banker remarked last month that the economy remains “strong.” More than likely, the outlook on expansion has to perform only well enough to allow the policy group to keep its concentration on inflation. Should growth hold steady, the RBA will remain fully occupied by core inflation hovering just below the central bank’s tolerance limit since peaking in 2006. Futures tied to Australian interest rates have priced in at least one more rate hike by the first quarter of 2008.
Australian monetary policy will continued to be measured against the Federal Reserve’s bias. The Australian dollar already enjoys a considerable 175 basis point premium over the US lending rate, but the forecast for future shifts in lending rates is clearly where the AUDUSD’s potential lies. The Fed has already set a somber tone for its own policy stance going forward, not to mention for other major central banks around the globe. On September 18th the Federal Open Market Committee announced its decision to cut the nation’s primary lending rate by 50 basis points to 4.75 percent.

Despite the considerable effort to forewarn the market of this impending shift from its previous neutral stance, the impact of the cut was hardly dampened. What’s more, expectations have been officially tipped lower, with further cuts priced into the futures market. However, there may be a glimmer of hope for the greenback. The minutes to the Fed’s two-day meeting in September offered no concrete indication of future cuts in the pipeline, perhaps buying time for the credit market to stabilize and inflation to come back into focus. After the report was digested by the markets, the probability of an October rate cut derived from Federal Funds futures dropped from 48 percent to 36 percent. So far, we have not seen a reaction in the AUD/USD despite a shift in interest rate expectations. This price action is important because it illustrates the overall demand for high yielding currencies.

Conclusion

After the Canadian currency’s momentous rise to parity against the benchmark US dollar, the strength of the commodity bloc and the significant weakness of the staple greenback were brought into focus. Considering the market currents that have consistently driven the loonie to its psychological high against the Forex market’s most liquid currency, it is easy to draw comparisons between USDCAD and AUDUSD. Australia is among the largest exporters of many of the world’s key commodities, while the US is one of the largest consumers of natural resources.

What’s more, the basic divergence in growth is clearly tipping towards the momentum underlying the Aussie economy with consumer spending, business investment and export income promising strength for the economy and currency in the months to come. Finally, the ever-present interest in the carry trade certainly favors the already high overnight lending rate attached to the Australian dollar, especially with the RBA holding true to its hawkish convictions and the Fed taking a big first step in a potential new easing trend. As a result, the Australian dollar hitting parity with the US dollar is not only possible, but probable.