• Market swings. US holiday overnight. US/Iran tensions supporting oil. JPY rebound weighing on USD & indirectly boosting currencies like the AUD.
• Macro pulse. RBA’s Hunter & Hauser speak today. US CPI this week. Markets factoring in ~60% chance Fed hikes next week & RBA moves this month.
Global Trends
With the US enjoying a long weekend holiday most financial markets were relatively quiet at the start of the new week. Tit-for-tat strikes between the US and Iran continue to dampen sentiment a little and are adding a risk premium to oil with brent crude now north of US$97/brl, ~21% above its 1-year average. The inflation impulse is underpinning long-end bond yields with 10yr rates in Germany and the UK climbing another ~4-5bps. The German 10yr (now ~3.39%) is around levels last traded in 2011 while the UK 10yr (now ~5.18%) is in a region it was last in in 2008.
In FX, the rebound in the undervalued JPY continues to be a key driver with the prospect of more bouts of FX intervention and ‘hawkish’ rhetoric from Bank of Japan officials that is pointing to further rate hikes factors at play. USD/JPY fell another ~1.2% yesterday, meaning that at ~154.30 it is now ~3.7% below where it was tracking a week ago and ~6% from the multi-decade peak touched in late-July. Given USD/JPY is the second most traded currency its movements indirectly impact others via its effects on the USD. EUR has edged up (now ~$1.1625), as has GBP (now ~$1.3542), while closer to home NZD consolidated (now ~$0.5878) and the AUD extended its upswing (now ~$0.7219).
After last Friday’s stronger than predicted US jobs report, which indicated the labour market is turning the corner after a few soft months (payrolls rose 162,000, the breadth of sectors adding jobs broadened, and unemployment held at a low 4.1%), odds of a rate hike by the US Fed next week have risen. The market is factoring in a ~60% chance the Fed raises rates, with a hike more than fully factored in by December and 2 moves discounted by next March. Given the focus on near-term policy actions the upcoming US producer price inflation (Thurs night AEST) and CPI data (Friday night AEST) will be in the spotlight. Based on the disconnect that has somewhat opened up between the USD and US interest rate expectations, we believe there could be a stronger FX reaction if the US CPI comes in stronger than predicted as this would bolster the case for the US Fed to shift settings further into ‘restrictive’ territory sooner rather than later. Moreover, while the ECB also looks set to lift interest rates again this week (Thursday night AEST), this is baked in and it may not commit to further action. A lack of strong forward guidance may be a disappointment for markets assuming more ECB rate rises this cycle. If realised, this could see the EUR (the major USD alternative) lose a bit of ground in the short-run.
Trans-Tasman Zone
The softer USD, largely a function of the rebound in the undervalued JPY, coupled with higher energy/base metal prices, and RBA rate hike expectations has given the AUD a further boost. At ~$0.7219 the AUD is at the top of the range it has occupied since mid-May, and is less than ~1% from the cyclical top reached in early May. The backdrop has also helped the AUD edge up on some of the major cross-rates. AUD/EUR (now ~0.6211) is around its year-to-date highs, AUD/GBP (now ~0.5331) is at a ~3-month peak, AUD/CNH (now ~4.8435) is above its ~6-month average, and AUD/NZD (now ~1.2281) is near levels last traded in 2013. By contrast, the relatively stronger recovery in the JPY has exerted downward pressure on AUD/JPY (now ~111.42).
Tonight, RBA Deputy Governor Hauser is being interviewed on TV (7:30pm AEST), and earlier on Assistant Governor Hunter is speaking (1:20pm AEST). Last week’s Australian GDP report showed that the level of activity is still outstripping supply. This, and Australia’s lackluster productivity is keeping inflation sticky. This is pointing to the RBA needing to move policy settings further into ‘restrictive’ territory. Markets are pricing in a ~62% chance of another RBA rate rise at the 29 September meeting, with a move more than fully discounted by the meeting on 3 November and ~43bps of tightening baked in by next May. It looks to be a matter of when, not if, the RBA acts again, though there is some risk markets have jumped the gun a little about a move in late-September given the monthly Australian CPI is released the day after the RBA meeting and policymakers may want to see if the last inflation print was a rouge number.
That said, whether the RBA tinkers a little more with interest rates shouldn’t really be a major driver for the AUD from here, in our opinion, based on what is now priced into the yield curve. The sharp rethink in the RBA outlook (from expected rate cuts to rate hikes) was important at the turn of the year, but FX is a relative price, and arguably other central banks have more to run in their cycles compared to what the RBA might deliver over the next few months. Moreover, markets have yet to contemplate the greater domestic economic pain even higher interest rates may inflict down the track in Australia given the high levels of household debt and downturn already unfolding in housing. These factors, combined with lingering issues in the global economy, could limit the AUD’s medium-term upside potential from current lofty heights, particularly as we believe the AUD already looks stretched compared to underlying drivers such as yield spreads and Asian currencies.
