Currencies | Oct 06 2010
By Chris Shaw
The Reserve Bank of Australia (RBA) decided to hold interest rates steady at its meeting yesterday, an announcement that caused a downward adjustment in the Australian yield curve and the Australian dollar.
Commonwealth Bank chief currency strategist Richard Grace notes the Overnight Index Swap (OIS) curve moved lower on the news, with the three-month OIS falling 18-basis points to 4.6% since the central bank decision.
The 12-month OIS has reacted in a similar fashion, falling by 19-basis points to 4.83%. As well, Grace notes the Australian three-year bond yield has fallen by 10-basis points to 4.71%, with some further downward adjustment likely in his view.
Falling yields suggest an adjustment lower in the Australian dollar is also likely. Grace suggests a decline to the 30-day moving average of 0.9335 against the US dollar is possible given the better than 9% appreciation in the Aussie dollar against the greenback over the past month.
In Grace's view the recent appreciation in the Australian currency is a major reason the RBA left rates unchanged, as the stronger dollar has effectively tightened monetary conditions to a level seen as appropriate for the time being.
With the short-end of the Australian yield curve declining on the back of the RBA decision Grace notes there is some additional pressure emerging on the Australia-US two-year bond spread. This spread has narrowed by 10-basis points to 4.28%, but in Grace's view the spread is unlikely to have peaked.
This is because the RBA's comments following the decision to keep the cash rate steady indicate future rate hikes remain on the central bank's agenda. This is to ensure inflation remains in line with medium-term targets.
Grace points out this is in contrast to the US, where the Federal Reserve appears prepared to become even more accommodative in monetary policy to support an economic recovery in the world's largest economy. This means there remains a high risk of further quantitative easing measures, a move expected to put additional downward pressure on both the US dollar and US two-year bond yields.
Given such an environment, Grace expects the Australia-US two-year bond spread will remain at elevated levels for an extended period of time. As well, if market volatility remains low, and Grace expects it will, there are likely to be fewer disruptions to push down the value of the Australian dollar, especially given an environment of firm Asian and global growth.
For Grace this means further appreciation in the Australian dollar can be expected, so there are no changes to his forecasts for the currency. These call for a rate against the US dollar of 0.9700 as at the end of December, 1.0200 at the end of March next year, 0.9900 at the end of next June and 0.9400 at the end of the September quarter next year.
The stronger Australian dollar in recent months has not been all good news for the Australian economy, Commonwealth Bank noting the stronger dollar means spot thermal coal prices have increased by less in Aussie dollar terms than in US dollar terms.
This has penalised local thermal coal sellers, a trend Commonwealth Bank expects may continue given expectations for the Australian dollar to again trade at parity or better against the US dollar in coming months.
