In a somewhat unusual situation, the central bank and markets are at odds with each other in Australia, particularly about the Australia CPI data. The wild shifts in inflation and rates over the last couple of years has made the occurrence a little more common, the bottom line is that the markets not agreeing with the authorities sets up a risky scenario.
One side will inevitably be wrong. Sometimes both. And that can generate a lot of volatility, particularly if it’s the market that has to adjust to the central bank. This has been the thread of the greenback though most of the year, and it’s also an issue affecting the Aussie. What could realign expectations and shake the currency is the release of key inflation data early on Wednesday.
What the Different Expectations Are
The markets believe rates have reached their peak, and it’s only a matter of time before they start going down. As for when, there is still a substantial amount of disagreement. A rate cut is only priced in fully for the December meeting. Expectations for a cut in September and October are near nil, as well. Traders are pricing in a 70% chance of rates remaining unchanged at the next meeting.
Following the last RBA meeting in which rates were left unchanged, Governor Michele Bullock pushed back on the market’s narrative, saying that it was too early to talk about cutting rates. The RBA is insistent that there will be no cuts in the “short term”, though how long is “short” is a matter of interpretation. Given that it’s in response to markets seeing a cut by the end of the year, “short” probably means the next four months. But, following the comments from the Governor, economists in turn also pushed back, saying that the RBA was contradicting itself in its forward guidance, since Bullock herself said there was no forward guidance. Economists seem to think the data will push the RBA to cutting before schedule.
What Does the Data Say?
The differing views are based on the expected evolution of the economy and inflation. Specifically, how fast the economy decelerates, since that is one of the main drivers of inflation. Australia CPI has persistently high inflation unlike other major currencies that saw their CPI rates come down in response to strong action by their central banks. But Australia’s reliance on China, and the Asian Giant going through a tough economic spot over the last couple of years, has crimped the RBA’s style.
The consensus is that the Australia CPI will reflect a drop in Australian inflation back to an annual rate of 3.6% from 3.8% in the prior measure. That would put it squarely above the RBA’s target of between 2.0% and 3.0%, though trending in the right direction.
Complicating Factors
One of the issues affecting the currency in particular is that Australia offers relatively high performance in its bonds. This has made it the target of carry trades, using the yen as a counterpart. Now that the yen carry trade is winding down, the situation remains somewhat fluid.
But, if the Fed starts cutting by as much as the markets think it will, and the RBA doesn’t follow, then the greenback could become a new source of carry trading. This prospect might end up forcing the RBA to cut earlier than it intended as it would likely push inflation down faster than is currently expected.