Latest Australian rate hike questionable

FUNDYS

The Australian Dollar has exploded to post-float record highs above parity on Tuesday, with the single currency now contemplating establishing itself above the psychological barrier following a decision by the Reserve Bank of Australia which caught most of the market off guard. The general consensus had been that the RBA would leave rates on hold at 4.50% in light of some softer inflation data and concerns over a potential slowing in the global economy. But the central bank felt that inflation was a serious concern going forward and reacted by raising rates by 25bps to 4.75%.

Relative Performance vs. USD Tuesday (As of 10:15GMT)

1. AUSSIE+1.23%
2. SWISSIE +0.65%
3. EURO+0.53%
4. CAD+0.36%
5. KIWI+0.26%
6. STERLING-0.17%
7. YEN-0.31%

We remain highly skeptical of the latest move by the RBA and feel that a central bank that has already been overly aggressive with its tight monetary policy has now moved itself even further away from being able to deal with any potential slowdown in the economy. In a global macro environment where central banks have been very cautious with moves to raise interest rates on fears of a potential slowdown, the RBA continues to ignore potential red flags and tightens its own policy. Australia has the highest interest rate amongst the major currencies, and this aggressive monetary policy has helped to propel the antipodean to fresh post-float record highs by parity.

We also find it extremely interesting to see such a disparity in the approach to monetary policy by the RBA relative to the Fed. While it is quite obvious that one central bank is tightening policy while the other is looking to accommodate further, this is not the disparity that we refer to. We find it quite fascinating that the RBA has been much less sensitive to market expectations, while the Fed has gone out of its way to be sensitive to what the markets are looking for. While we can certainly be critical of the Fed for gauging the opinion of the market to help make its decision, we are much more critical of an RBA that ignores consensus estimates and moves to raise rates in an environment where most would have been perfectly satisfied with a no-change decision.

We believe that just as there are risks to the US economy if the Fed is too accommodative this week, there are equal risks to the Australian economy if the RBA is too aggressive. In fact we would take it a step further and say that the Fed should be less concerned with market demands and more independent in its decision making, while the RBA should be more sensitive to what the markets are looking for.

Technically, we continue to argue that the Australian Dollar is by cyclical highs and this in conjunction with some stretched medium-term and longer-term studies, leaves the market at risk for a serious pullback over the near-term. While we would not rule out the possibility for another attempt to hold above parity, we do not expect to see any gains beyond this critical psychological barrier as sustainable. We have gone ahead and issued a recommendation to sell at 1.0005 today with an open objective and stop-loss by 1.0115.

Elsewhere, a quiet session of Asian trade picked up in Europe, with the US Dollar coming under some more pressure against most of the other major currencies. Kiwi traded to fresh multi-month highs by 0.7700, while the Franc decided to finally mount a recovery after being relatively well offered in recent trade. Most market participants however remained focused on EUR/USD which, despite some gains, still remained well confined to familiar ranges. On the data front, German and Eurozone manufacturing PMIs came in on the better side of expectation, while UK data was far less impressive after construction PMI came in well below analyst forecasts.

Looking ahead, trade is expected to be quite busy in North America, with pre-FOMC positioning, and mid-term elections all factoring into volatility. There are no major economic releases, with the only noteworthy data coming from some secondary oil and gas inventory numbers. US equity futures are tracking higher, while commodities are mixed with oil up and gold flat.

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