Why Would the Australian Dollar Selloff after an RBA Rate Decision?

Reflecting on last week’s price action, there is little doubt that risk appetite was on the rise. Equities, commodities and bond yields were all advancing to new highs and finally doing so with significant momentum. Closer to home, the taste for risk was weighing on the funding and safe haven currencies while those currencies that were depressed by risk made an effort at recovery. However, for the Australian dollar – a currency that is already at the top of the yield curve and has not seen its premium altered by risk concerns – the shift in optimism would produce very little response. On the one hand, this may be a sign that the boost in investor confidence is relatively weak. Alternatively, it could point to a problem in the currency itself. Where is there room for uncertainty or bearishness for the market’s best performer? It is exactly the case that Aussie dollar has been considered the best positioned currency since the market recovery began last year that weakens resolve. Its current level reflects not only its static strength, but the expectations for future growth and return as well. All that is needed is one significant disappointment when the rest of the market is playing catch up for the Australian dollar’s rally to collapse under its own weight.

If there is a single event that can dramatically alter the outlook on this single currency; it is a shift in the monetary policy regime. Already holding near recent historical highs, to feed momentum and carry the market to new highs requires a consistent deterioration in the health of the Aussie’s peers or a constant improvement in the currencies own fundamental backdrop. The former scenario will not happen. In fact, the health of the global economy is improving rapidly and the interest rate outlook calls for a significant round of tightening for most of the major central banks over a six to twelve month time span. That leaves us with the Australia’s and the RBA’s performance. Data is certainly impress, but the strains of global stagnation and the aftereffects of previous policy hikes are showing through in economic activity.  That leverages an even greater dependency on monetary policy.

Early forecasts for the outcome of the meeting are calling for yet another hike to 4.25 percent. Economists heavily favor such an outcome and the market is pricing in a 65 percent probability of the same. However, recent data has more clearly reflected a stalling in activity following previous policy actions (notably retail sales and a few ancillary housing numbers). What’s more, China, the region’s largest economy and consumer of the vast majority of Australian exports, has announced some time ago that it was taking measures to cool its economy and markets. Just this past week, they have even warned of asset bubbles. Continuing to raise rates when the risk of a ‘W’-shaped global recovery is rising and when the rest of the world is holding off on tightening themselves is a dangerous and highly speculative position. Yet, since the market is already pricing in a hike; if the market doesn’t get one, the Aussie dollar could plunge. - JK