The apparent willingness of Federal Reserve officials to increase U.S. interest rates this year means incoming Reserve Bank of Australia (RBA) Governor Philip Lowe may have the ability to hold onto the policy ammunition that his predecessor bequeaths him.
Fed Chair Janet Yellen’s comments at the weekend that the case for an interest-rate hike has strengthened in recent months drove the Australian dollar down against the greenback as traders saw 65% odds that U.S. benchmark borrowing costs will be higher by year-end.
Some relief on the currency front could enable the RBA to hold fire on further reductions to a cash rate that it’s already been cut to a record-low 1.5%. The swaps market was pricing in just a 45% probability of a reduction in Australia by Dec. 31, according to data compiled by Bloomberg.
The Australian currency declined 0.8% last week, its first back-to-back weekly slide since May. It was at 75.54 U.S. cents as of 9 a.m. on Monday in Sydney, after reaching a three-month high of 77.56 earlier in August. Weaker-than-target inflation has already forced the RBA to lower its key rate by half a per cent this year, and the central bank has said that an appreciating exchange rate could “complicate’’ the economy’s shift toward growth drivers outside of the mining industry.
Lowe is slated to take over from Glenn Stevens as RBA chief in three weeks’ time.
“If the increase in chances of a Fed move strengthens the dollar and softens the Aussie, that would be a welcome development for the RBA,” said Ray Attrill, global co-head of foreign-exchange strategy at National Australia Bank Ltd. in Sydney. “Then they would be less inclined to follow up on the two rate cuts this year.”
The higher yield offered on Australia’s debt is a key factor helping to buoy the currency, especially as investors seek out alternatives to the negative rates in places like Japan and Europe. Australia’s benchmark 10-year bond yield climbed 6 basis points to 1.91%, compared with 1.63% for equivalent U.S. securities. The three-year rate rose 5 basis points to 1.46%.
The premium that 10-year Aussie notes offer over Treasuries last week shrank to the narrowest since March 2001. Even so, with yields on similar-dated securities below zero in Germany and Japan, the Australian dollar has gained 3.7% this year as investors seek positive rates.
While the Sydney-based central bank is tipped by economists to stand pat at Stevens’ final policy meeting on 6 September, opinion is more divided over the prospects for a move later in the year. The RBA has of late tended to shift policy in months that coincided with an update to their quarterly economic forecasts, and the next such gathering will take place in November. Of the 32 economists surveyed by Bloomberg News, seven reckon there will be a cut by year end.
Much of what happens will depend on the Fed. Goldman Sachs Group Inc. said a U.S. rate hike next month is now very much on the table after comments from Yellen and Vice Chairman Stanley Fischer at a conference of central bankers and economists in Jackson Hole, Wyoming.
The Fed chair expressed confidence that tighter labor markets over time will push inflation back to the central bank’s 2% goal, setting up a rate hike this year. Fischer said in an interview that her remarks leave open the possibility of a September hike.
