I need to concentrate on what happened a Martin Place this week because the RBA has decided to follow its bigger brothers and sisters of other central banks and tell the world don’t worry about inflation.
I will come back to this point and what it means for FX, but it must be said that the market still isn’t convinced inflation isn’t a problem.
First point: the RBA did something it hasn’t in many a year – its surprised the market at its board meeting.
The current quantitative easing program will be increased by a further $100 billion with the second tranche of the program rolling out at the close of the first which could be as early as April 9 – this wasn’t a surprise as most had expected it would be continued.
The surprise was that it announced the second tranche ‘now’ rather than what it usually does which is to foreshadow a move then action in the month it needs to start, in this can April.
The surprise announcement did push on the Australian 10-year bond yield moving it down over 8 basis points, however that his was short lived.
In the same statement the RBA also signalled that Australia’s cash rate is now ‘set’ until 2024, in fact the statement suggests it could be longer than this noting that inflation would need to be ‘materially higher’ before rates could rise.
Basically, the RBA is following the Federal Reserve’s playbook on how ‘manage’ this situation. Considering the RBA’s mandate for core inflation is 2% to 3% and it hasn’t been in this band since the third quarter of 2015 – 2024 maybe too short a time frame.
In fact, Governor Lowe let slip what the board might be looking for to even consider rate rises when he testified to the standing committee on Friday stating – ‘the board would need to see a couple of quarter of inflation above 2.2% before it could even consider rising rates.’
2024 looks optimistic under this scenario.
But, this hasn’t stop the market from speculating that inflation could pop in the coming months. In fact, Deputy Governor of the RBA Guy Debelle even forewarned that inflation could indeed pop in the coming months as the COVID crisis blow back reaches a peak at the same Standing Committee hearing.
Which explains why bond yields are continuing to ratchet higher. The spread in US 3-30 year is back at 2013/14 levels the Australian 2-10 year spread continues to show that the market believes inflation is a real threat to current conditions, it the same in other market where the COVID crisis is easing.
What that has meant for FX has been interesting, the USD is clearly becoming attractive and if yields continue to rise outside of the Fed’s wants it will drive inflows. The AUD too is fluctuating on a falling iron ore price but a high inflation story. As an example, the AUD/USD actually rose back above $0.76 on the standing committee testimony and the comments made by Debelle. So which bond spread will win out? the answer might be ‘Don’t fight the Fed’.
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