Australian Dollar Could Snap Back to Trend with an RBA Surprise

In a world plagued by risk and uncertainty, what is the only thing that can soothe a nervous trader? High returns. The markets are always establishing a balance between risk appetite and risk aversion; and there is a utility for a greater yield income in compensating for the risk of future volatility. The Australian central bank is already the highest in the industrial world at 3.75 percent; but this good will seems to have already been fully priced into its current value. To revive the currency’s advance, investors want the promise of higher returns (which conspicuously increases regular interest income, but it also generates capital returns as more money flows in to capture the growing differential). A hike would certainly be a bullish outcome for the single currency; but its overall influence may be limited. The consensus among economists is for a quarter-point hike to 4.00 percent. And, while there is an uncertainty factor with overnight index swaps pricing in a more unbiased 49 percent probability of such an outcome; the outlook over the coming 12 months is still calling 100 basis points worth of firming. It looks to be the case that the market is already pricing in a hike; and thereby a hold could prove a greater burden to the currency than a hike could perform as a bullish driver. Furthermore, the commentary will give a good feeling for the pace of hawkish progression the central bank makes going forward. At the last meeting, Governor Glenn Stevens seemed more comfortable with a ‘wait-and-see’ approach that would allow for previous policy changes to take effect. However, given more recent rhetoric, he be ready to change the tempo again.

In the world of assessing the strength or weakness of currencies, relative yield is a primary source of value. However, it isn’t the only one. Another key lure for capital is relative growth. From this angle, the Australian dollar is once again the clear cut leader amongst its peers. Able to avoid a technical recession, the economy has been able to mark a meaningful recovery through relatively robust domestic demand and strong demand for exports from its outperforming Asian neighbors. Yet, a global outlook that points to a moderate rate of expansion and projections from Standard & Poor’s for Chinese markets to under a significant correction in 2010 (not to mention government efforts to slow this giant’s markets and economy down) could end up killing the golden goose for Australia. We will see whether this is a fundamental concern for a later date with the 4Q GDP figures due the day after the rate decision. Forecasts call for 0.9 percent growth through the three-month period and a 2.4 percent pace through the year. What’s more, the addition of more timely manufacturing, service activity, retail sales, trade and construction data will guide expectations for the first quarter.  - JK