Missing the boat. Will the Fed’s moves outpace the RBA?
The Aussie dollar starts the new week at the lowest level since February 2016, down more than 14 per cent from the year’s highs.
There’s been a number of reasons for the AUD’s falls. First, the US dollar has surged higher as the US Federal Reserve raised rates three times in 2018. Second, the ongoing drama of the US-China trade wars has also weighed on the local currency.
However, by far the largest drag on the Aussie’s performance has been the shift in expectations for local interest rates.
According to data from the ASX’s bond market futures, we started the year with markets predicting a local rate hike by November of this year.
As we approach November, the bond market has significantly pulled away from these predictions. Instead, the bond market doesn’t forecast a local rate hike until mid-2020 (source: ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve, 5 October 2018).
Local forecasters hold firm
The big move in the AUD and local interest rates market hasn’t particularly shifted forecasters.
For example, despite the AUDUSD’s 14 per cent fall in 2018, the view of FX analysts is virtually unchanged.
According the to the Reuters FX Poll, the 12-month forecast at the start of the year was 0.7700. Now, the 12-month forecast is at 0.7500 (Source: Reuters 3 October 2018).
Importantly, the projected range of forecasts from the Reuters’ poll is completely unchanged over the course of the year: with a 12-month high still at 0.8500 and a 12-month low still at 0.6800. It’s as if the AUDUSD’s 14 per cent fall has occurred in a vacuum.
The same inertia has characterised the Reuters’ interest rate survey. At the start of this year, only one forecaster was brave enough to predict the Reserve Bank of Australia might make as cut its next move.
Now, after a marked change in interest rate pricing, and with the bond market signalling that a cut is more likely until at least April next year, only two forecasters are willing to predict the RBA might make its next move a cut (Saxo Bank and super fund Host Plus).
Missing the boat?
Clearly, the risk is that events will overtake relative comfort of the Australian financial sector.
The US Federal Reserve has been raising rates since December 2015. While it must be noted that this has been a very slow climb, historically, hiking cycles are done-and-dusted within three years.
Of the last three hiking cycles, centred around 1994, 1999 and 2005, the longest was the two years between June 2004 and June 2006. The other two hiking cycles lasted less than a year.
I believe the major risk for the Australian dollar is that the RBA misses the window to hike rates while the global economy is strong. With the US Fed potentially nearing the end of its rate hiking cycle, will the RBA be willing to hike in 2020 as the market and many forecasters expect?
If the RBA isn’t willing to hike, then the next move might be further rate cuts. And what will this mean for the Australian dollar? It opens up the possibility of a move to the low 0.6000s, a possibility that many in the market are still seemingly yet to recognise.