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RBA points out the risk of thinking that 'pause' means 'peak'

The Reserve Bank of Australia raised rates by 25bp to 3.85% today, surprising the market which had been lulled into thinking that they would not do anything at this meeting. The market had reason to think that the RBA would keep rates steady of course, as they had kept the cash rate unchanged at 3.6% at their meeting on 04 April 2023. At that meeting they pointed out that inflation looks to be peaking in Australia, economic activity was slowing, but the jobs market remained tight. They, as many other central banks are doing, were looking at wage growth as an inflation indicator.

The RBA did warn the market in the last paragraph of their April statement that “The Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target. The decision to hold interest rates steady this month provides the Board with more time to assess the state of the economy and the outlook, in an environment of considerable uncertainty.” In other words, they kept the door open for rate hikes. Why were analysts surprised when they raised rates today? Inflation is up, wage growth is holding up, the labour market is still tight. But it seems that most analysts thought that the pause in the rate hikes would last more than one month, and some may have thought that ‘pause’ meant ‘peak’.

The chart below shows the AUD 90-day bank bill futures implied rate as a proxy for market rate expectations. The red line is the current pricing, the light blue line is the implied expectations 3 months ago, and the dark blue line is the markets guess 12 months ago. The surprise rate hike today pushed the short-dated rate up a touch from where the guess was 3 months ago, but the curve flattens out and drops further out – at a lower level than it did 3 months ago. This suggests that analysts (and more importantly, traders) are taking the view that the RBA bumped rates up today, and they may push rates above 4%, but not by much, and not for long.

The chart below shows the knee-jerk AUD/USD response to the rate hike (hourly chart). The AUD firmed a bit, and no doubt traders are waiting for London/NY to take a look and think about events.

The chart below is the daily chart of the AUD/USD going back to just before Covid sent the USD flying in 2020. What now? We are still looking for the AUD to firm towards $0.74/$0.76 over the next 12 months, but rallying away from the $0.65 area (and not pressing below $0.62/$0.60) will be important over the coming weeks.

Looking beyond the RBA and the AUD, what does this mean for other central banks? Potentially nothing, they are all different and in a world where we wonder what jobs AI could do better than people, central bankers may stand out as folk that a clever bit of software could replace and not many people would notice the difference. Lots of bad economic headlines? Cut rates. Really bad headlines? Buy bonds and other assets until the stock market (as a proxy for confidence) turns up, consider negative rates. Boom economy and inflation perking up? Raise rates and embark on quantitative tightening. Easy, right? Well…

On a serious note, we now need to take on board the view that pause does not necessarily mean peak. The scenario that the tea leaf watchers dream of where the Fed (and others) could ‘twitch’ and snug rates up a bit or down a bit as they ‘directionally pause’ could be at hand. This means 25 bp up, maybe another 25 bp after that, then 25 bp down, maybe another 25 bp after that, then 25 bp up etc. No more up 500 bp (perhaps) and then down 500 bp over the next few years. Hmmm….

Gerry Celaya

Chief Strategist

Keywords: AUD USD RBA FX Currency

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