Royal Bank of Australia Causes Stir with Latest Rate Announcement

Includes: FXA, FXY, UDN, UUP
by: Dr. Duru

The Royal Bank of Australia (RBA) surprised markets by leaving rates unchanged at 3.75%. Forecasts pegged the RBA for another 25 basis point increase. The markets reacted with an instant and steep drop in the Aussie dollar against all major currencies. For example, the Aussie dollar dropped over 1% against the U.S. dollar.

The Aussie dollar was not the only currency on the move in response to the RBA announcement. The Japanese yen strengthened slightly against all major currencies, followed by renewed strength in the U.S. dollar. I am guessing that the RBA sent some chills into the market by acknowledging problems with sovereign debt: “Concerns regarding some sovereigns have increased.” It is a simple statement, but often that is all it takes – it raises eyebrows, invites speculation, and refreshes risk aversion trades.

I think the selling in the Aussie dollar is overdone and will create a great buying opportunity in the near future. The RBA clearly stated that it is ready to raise rates again once it is clear the economy continues to improve (emphasis mine):

With the risk of serious economic contraction in Australia having passed, the Board had moved at recent meetings to lessen the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker. Lenders have generally raised rates a little more than the cash rate over recent months and most loan rates have risen by close to a percentage point. Since information about the early impact of those changes is still limited, the Board judged it appropriate to hold a steady setting of monetary policy for the time being.

Interest rates to most borrowers nonetheless remain lower than average. If economic conditions evolve broadly as expected, the Board considers it likely that monetary policy will, over time, need to be adjusted further in order to ensure that inflation remains consistent with the target over the medium term.

I expect the Australian economy to continue its relative strength – even as the Chinese more aggressively fight inflationary pressures – so I remain bullish on the Australian dollar, especially against the U.S. dollar.

Be careful out there.

Disclosure: long AUD/USD, long FXA, long USD/JPY