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Summary

  • Expectations for a rate cut in Australia have snapped back to recent low levels.
  • The Australian dollar has gained fresh strength on lowered rate expectations.
  • The Reserve Bank of Australia can apparently only wait out negative fundamentals to run their course on the currency.

For some time now, the Reserve Bank of Australia (RBA) has consistently stated:

In the Board's judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.

Expectations for a rate cut in September remained around 4% after that meeting. Shortly after the August 5th decision, the July jobs report showed an employment situation that had decidedly worsened. Accordingly, expectations for a rate cut in September jumped upward to 9% and then 11%. Still low odds overall, but the rate and direction of change seemed significant in reinforcing the parallel drop in the Australian dollar (NYSEARCA:FXA). That drop turned out to be very temporary. The odds of a rate cut in September have snapped right back to 4%.

A temporary disturbance in low expectations for a rate cut

Source: RBA Rate Indicator - September 2014

Just as the Australian dollar dropped along with the rise in expectations for a rate cut, the currency has snapped back along with the drop in expectations. The Australian dollar has snapped back against all the major currencies I follow. In particular, the currency's rise against the Japanese yen helped solidify my opinion that the S&P 500 (NYSEARCA:SPY) would continue to bounce from oversold conditions.

The Australian dollar remains in "bullish" territory against the Japanese yen

Source: FreeStockCharts.com

The Reserve Bank of Australia remains in a quandary over its stubbornly resilient currency. It cannot credibly promise the fresh cycle of rate cuts that would be required to convince currency markets to take the Australian dollar lower and closer to the RBA's "target." Jawboning has pretty much run its course since RBA Governor Glenn Stevens last tried it in early July. All the RBA can do, apparently, is continue to wait out the decline in commodity prices, the drop in terms of trade, and the steady increase in unemployment until THOSE catalysts finally convince markets that the small carry trade differentials are no longer worth the substantial downside risks.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am net short the Australian dollar

Source: The Australian Dollar Follows Recent Change In Rate Expectations