The Australian dollar fell heavily yesterday, trading down to 0.7440/50 in the wake of the inflation report. Clearly forex traders had been betting that the data would be stronger.
But the fact that it’s back above 75 cents this morning while Australia’s 2 and 10 year bonds rates are rallying, and given the market wisdom in the wake of the CPI release is that it’s still a certainty the RBA will cut rates, is testament to the attractiveness of Australia as receptacle for global investment flows in a world of low rates.
While most commentators who believe the RBA will cut next cite inflation as a key driver, there are many who also believe the RBA should cut in order to avert an Aussie dollar rally back toward 78 cents.
But taken together, the bond market rally and the rise in the Australian dollar today suggest that there is no guarantee an RBA rate cut will work if driving the Aussie dollar lower is one of their motivations.
That’s because in the same way that low inflation is a global problem that has found its way to Australia, so too the global interest rate and market outlook continues to support the Aussie dollar.
In a note released earlier today, Mark Kiesel, PIMCO’s chief investment officer of global credit, highlighted that “aggregate bond markets have outperformed global equity markets year to date”. He characterised the rally in bond rates as a “search for yield amid [this] appetite for income” which “is complicated by the reality that almost $12 trillion in bonds in the Barclays Global Aggregate Index are now at negative yields including more than 80% of Japanese and German government bonds”.
The point of Kiesel’s note is to highlight the attractiveness of US corporate bonds where he says “investors can still seek potential yields of 3%–6%”.
But in this light, and in light of negative rates in so much of the developed world, Australia as a AAA rated nation with 2 years rates around 1.6%, and 10 year bond rates around 1.9% continues to stand out for global investors.
That’s the complicating factor for the RBA.
It’s also the big question a central bank board inclined to cut to ease the Aussie dollar lower might need to ask itself. Unless it promises multiple rate cuts, if it moves next week, will the RBA, and the Aussie, suffer the same fate that the RBNZ, and the New Zealand dollar, have suffered since their own rate cut from 2.50% to 2.25% back in March?
Since then the Kiwi has rallied from the around the 66/67 cent region against the US dollar to sit at 71 cents this morning. That’s even after the RBNZ took the unprecedented step of issuing an intra-meeting economic assessment to signal another rate cut is coming.
Yesterday’s Q2 inflation report in Australia had something for everyone. The RBA can still make the case at next Tuesday’s board meeting, if it chooses to, that inflation is low enough to warrant another rate cut to shore up economic growth and inflation expectations.
But if it’s targeting the Aussie dollar as a reason to cut rates, the continued attractiveness of the Australian bond market, and Australia’s rate structure means that it is going to have to promise several cuts to drive the Aussie sustainably lower.
That just might be a bridge too far.