Australian Dollar Plunge on Weak CPI Gives Japanese Yen a Boost

How Did the Markets React? 

The release of significantly softer-than-expected Australian inflation for the fourth quarter not only caused frenzy buying in fixed income and equity markets and a sell off of Australian dollars, but also made a huge impact on the long-suffering Japanese Yen. Consumer prices, as measured by the Australian Bureau of Statistics, dropped for the first time in nearly eight years at a quarterly rate of 0.1 percent, bringing the annual rate to dip to 3.3 percent – much closer to the Reserve Bank ofAustralia’s target ceiling of 3.0 percent. Weaker oil prices led the decline, as gasoline costs fell 12.4 percent. Additionally, fruit prices dropped 5.2 percent while medicines declined 5.0 percent. Meanwhile, the RBA’s own “trimmed measure” of inflation unexpectedly slowed, rising a less-than-expected 0.5 percent during the quarter, leaving the annual figure steady at 2.9 percent.  With the Bureau’s measure of inflation edging more comfortably towards the RBA’s target range and the “trimmed measure” staying inside of it, Governor Glenn Steven is far less likely to tighten monetary policy in February after hiking rates three times in 2006 to bring the Australian benchmark to a six-year high of 6.25 percent.

Bonds – Australian 10-Year Treasury Bonds

Yields on Australian 10-year treasury bonds nosedived from 5.831 percent to a low of 5.814 percent on the release of fourth quarter consumer price data. As a result, prices on Australian debt rallied to .70 to 101.38 as traders slashed expectations of a February rate hike by the RBA. However, with wage data for the fourth quarter set to be released in mid-February, Aussie debt may not be able to hold onto gains, as a stronger result could signal price pressures in the pipeline and leave the door open for a March RBA hike.

Source: Bloomberg

FX – AUD/USD, AUD/JPY, USD/JPY

The release of tepid Australian CPI resonated through the FX markets, as the plunge of the Australian dollar gave an unexpected boost to the Japanese Yen, which has been trading at four year lows. The Australian inflation data pushed AUD/USD 100 points lower to 0.7827 within an hour of the release. Meanwhile, the Australian dollar experienced large losses against the Japanese Yen, sending the AUD/JPY cross from 96.45 to 95.28 within an hour of the inflation release. The early European session saw the pair down even further to a low of 94.29 as traders continued to unwind highly profitable carry trades.  As a result, Japanese Yen extended its gains into the USD/JPY pair, which dropped more than 100 points from an Asian session high of 121.81 to a European session low of 120.64. The Japanese Yen may be unable to hold onto its recent gains, however. While higher-yielding countries such as Australia and the US are more likely to keep rates steady, the Bank of Japan has little impetus to raise rates from the current 0.25 percent and should continue to make for an attractive carry trade.

USD/JPY (Intraday)

Source: Bloomberg

Equities – S&P/ASX 200 Index

Australian stocks extended a record by rising for a fifth day and bringing the S&P/ASX 200 Index to rise 33.80, or 0.6 percent, to 5768.80 at the Sydney close. While the gain was led by resources companies after commodity prices, including copper and crude oil, climbed, banking shares also profited after the release of weaker-than expected consumer prices. With inflation easing, the Reserve Bank of Australia is far less likely to raise interest rates in February, boding well for the financial sector. Commonwealth Bank, the nation's second-biggest bank, climbed 0.4 percent, to A$50.16. Australia & New Zealand Banking Group Ltd., the third-biggest, also added 0.4 percent to A$28.80. Meanwhile, BHP, the world's biggest mining company by market value and production, climbed 62 cents, or 2.5 percent, to A$25.90. Rio Tinto, the second-biggest by market value and third by production, rose A$2.39, or 3.3 percent, to A$76.

 S&P/ASX 200 Index (Intraday)

Source: Bloomberg