Tuesday, October 5, 2010

Rates Down Under

The AUD/USD pair corrosively sold off the moment the rate decision became apparent at 11:30 EST. The pair rallied more than 150 pips since the initial sell-off and now trades higher around 0.972o. Unfortunately, I was on the wrong side of this trade. Lesson learned.

Interest rate day came and went.  The RBA decided not to raise rates by the sure-fire economist/analyst prediction of 25 basis points.  Instead, rates stayed in check at 4.50%.  Central Bank Governor Glenn Stevens explained:

Financial markets are still characterized by a degree of uncertainty, and are responding both to differences in growth outlooks between regions and evident strains on public finances and banking systems in several smaller countries in Europe. Most commodity prices have changed little over recent months, and those most important to Australia remain very high.

The tacit implication here is that while commodity prices continue to rise, notably Copper, the substantial appreciation of the “Aussie” supplants any real threats of inflation in the near-term.  I surmise the central bank employed this policy to assist in job creation through private sector reinvestment, which in turn may help reignite housing demand and retail sales.  In the minutes the RBA suggested higher rates over a mid-term period.  The central bank did note cooling domestic demand and global economic uncertainty as concerns:

Several measures of inflation expectations had eased a little over recent months to be around average levels. Similarly, business surveys reported that the share of businesses planning to increase their prices over coming months was around average…While policy had to be alert to these risks, members considered that if the central scenario came to pass it was likely that higher interest rates would be required, at some point, to ensure that inflation remained consistent with the medium-term target. For the immediate decision, there had been no significant change in the overall outlook, with conditions looking a little stronger domestically than they had at the previous meeting, but looking a little weaker internationally.

In addition, I found the IMF’s recent comments in their annual Article IV moderately firmer than those found in the most recent RBA minutes:

Should the recovery unfold as expected, monetary policy will need to tighten further to contain inflation pressures generated by the mining boom… from a medium-term perspective, our assessment is that the exchange rate is mildly overvalued… This overvaluation is likely to be temporary and may dissipate with the eventual normalization of interest rates in the United States and other advanced economies.”

Here, The IMF argues interest rate policy (tightening) as the correct tool to cool inflation.  Conversely, the RBA seemed content to let the ‘Aussie” appreciate and reap the benefits of cheaper cost of capital and simultaneously increase prices of exported commodities.  Note, as the CNY remains weak against the USD, imports from Australia become more expensive for the People's Republic of China. Either way, inflation will cool. 

What caused economists and analysts to maintain such conviction of an interest rate hike?  The empirical reason may never be discerned.  I maintain a theory though. Many rumors sloshed between investors, traders, and media pundits that the Central Bank Governor openly desired hirer rates. However, Mr. Stevens did not lay his cards on the table in between the release of RBA minutes on September 7th and the rate decision on October 5th.  Thus, many of ‘us’ were fooled.  Next time 'we 'ought to err on the side of caution when attempting to forecast a Central Banker’s policy decision.

--Patrick M. Ambrus


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