FX Update: RBA punishes AUD. Fed Chair Powell testimony on tap.

Today's Saxo Market Call podcast
Today's Global Market Quick Take: Europe from the Saxo Strategy Team

FX Trading focus: RBA punishes the Aussie with its dovish hike. Remarkable spread of ECB vs. RBA expectations.  Fed Chair Powell testimony may not offer much.

The RBA hiked 25 bps overnight as widely expected, taking the cash rate target to 3.6%. The market read the statement as dovish on a small change of phrase In the guidance on further tightening, with February’s “In assessing how much further interest rates need to increase”, changed in today’s statement to “In assessing when and how much further interest rates need to increase”. The insertion of “when” is a tip-off that the RBA is looking for excuses to pause its tightening regime at one or more meetings to assess developments. Australia’s 2-year yield dropped some 14 basis points as the RBA is priced to reach a terminal rate now only about 40 basis points higher, near 4.00%. While the RBA is concerned that services inflation remains too high, it is clearly very concerned as well on the risks to the economy from the lagged impact of prior tightening already in the bag, particularly for households with adjustable rate mortgages. Some 800,000 mortgages taken out during the pandemic are due for a reset this year, with massive upward adjustments for payments as the mortgages roll to a new rate that is more than twice as high as those during the pandemic. An article from news.com.au suggests that the average Australian mortgage is AUD 600k, equating to a rise of about AUD 16,500 in interest costs over 12 months at the new rate.

But is the RBA at risk of a policy mistake? Time will tell, but it is certainly notable that the central banks trying to come in for a pause, including the Bank of Canada, risk another embarrassing pivot if inflation proves more persistent than expected, as is our base case. Also notable is that the ECB and the RBA terminal rate expectations are nearing parity at 4.00%! Who would have thought this was possible in any of the prior cycles of the last 20 years?

As noted in this morning’s Saxo Market Call podcast, the ECB is priced to do more than 150 basis points of further tightening, the most additional tightening in the coming two quarters of any DM central bank. That is beginning to look a bit stretched in relative terms. Of course, we must also recall how late cycle the ECB has been in past cycles relative to other central banks. Remember the actions of one of the most out-of-touch central bankers of the modern era. Jean Claude Trichet, who hike two months before Lehman Brothers’ collapse and again in the midst of the EU sovereign debt crisis in 2011.  

Chart: AUDUSD
New lows for AUDUSD here locally after the dovish RBA move, which pushes the focus lower to the next target, the 61.8% retracement of the rally from the lows, which comes in near 0.6550. Ironic to see one of the historically favoured commodity proxies struggling for air at a time when we are supposed to be celebrating a new rebound in Chinese growth, which has only shown up in fits and starts in metals markets. AUD is more in the grips of the RBA’s foot-dragging on tightening. RBA Governor Lowe will speak tonight and may try to pushback against the aggressive market takeaway if he wants to insist on two-way potential from here for the RBA’s next actions.