The Australian Dollar roared to a 10-month high last week as the US Dollar collapsed on hopes that the Federal Reserve might be stepping back from their hawkish stance. The focus now turns to the RBA meeting this Tuesday.
The Federal Open Market Committee (FOMC) lifted rates by 25 basis points (bp), but it was in the post-meeting press conference where the fireworks kicked off.
Fed Chair Jerome Powell mostly stuck to the script, but markets gushed when he said, “We can now say I think for the first time that the disinflationary process has started.”
This created a buying frenzy of equities and bonds and the broad-based selling of US Dollars, pushing AUD/USD to its peak of 0.7158.
Treasury yields collapsed, dragging global government bond yields down with them. Australian Commonwealth Government Bonds (ACGB) yields fell further with the 10-year bond spread returning to around parity.
The contraction in the spread occurred at the same time that AUD/USD dropped.
Australian CPI is running hot at 7.8% year-on-year, but the RBA has previously appeared non-plussed about the massive overshoot from their 2-3% mandated target band. At their last meeting, they stated that they expect it to climb above 8% later this year before easing in 2022.
The domestic economy is on fire. Building approvals for December were up 18% compared to the month prior. The trade surplus keeps washing in billions of dollars each month and the unemployment rate remains near multi-generational lows at 3.5%.
The December trade balance will be released just prior to the RBA meeting on Tuesday and a Bloomberg survey of economists is anticipating an AUD 12.4 billion surplus.
December retail sales is the only blight on the economic scorecard, but this has been mostly attributed to consumers pre-buying ahead of Christmas in November.
So, with the national finances in such great shape, why is the RBA not slamming on the brakes and reining in inflation?
A lot may have to do with the so-called ‘mortgage cliff’. A significant amount of fixed-rate loans that were taken out when the cash rate was 300 bp lower are due to roll off this year.
A degree of controversy surrounds the RBA due to media misreporting Governor Philip Lowe’s comments about how long rates will be kept at the pandemic emergency low setting.
Whatever the reasoning for the RBA not being more aggressive in their inflation fight, they have made it clear that they are in somewhat of a wait-and-see mode for now. A 25 bp lift in rates is widely anticipated this week.
With China re-opening, a blistering domestic economy and if the US Dollar keeps sailing south, the Aussie might be moving north.
AUD/USD AGAINST AU-US GOVERNMENT BOND SPREAD