Monetary policy considerations are front and center for the Australian Dollar in the week ahead, with key event risk on tap on the domestic and the external fronts. First, the RBA will deliver its monthly policy announcement. Then, minutes from the March meeting of the Federal Reserve’s rate-setting FOMC committee will give insight on policymakers’ thinking about on-coming rate hike prospects.
For its part, the RBA is expected to keep the benchmark lending rate unchanged at 2 percent. Markets price in a mere 6 percent chance of a cut this time. Australian economic news-flow began to deteriorate in late January, but this didn’t seem to perturb the central bank last month. Things began to stabilize mid-March, suggesting Governor Glen Stevens and company probably feel comfortable remaining in wait-and-see mode. Signaling as much in the policy statement may make for something of a non-event.
This paves the way for risk appetite trends to take the reins, with the outlook on Fed policy still the theme du jour. We’ve argued that Chair Yellen and company marked a discrete pivot in their policy approach last month. This followed the realization that a wide disparity in official and market-based 2016 tightening bets since December’s “liftoff” (4 versus 2 hikes, respectively) triggered self-defeating risk aversion that undermined their ability to proceed with normalization.
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With that in mind, policymakers have taken to repeating a broadly coordinated message arguing that despite adequate progress on mandate fundamentals domestically, rate hikes are being delayed by worries about spillover from outside headwinds. In as much as the concerns being cited are stale at best (the slowdown in China, weak oil prices and a strong US Dollar) and had been dismissed as broadly inconsequential previously even as the threat they posed was more acute, this sounds like code.
Specifically, the Fed wants to avoid triggering another counter-productive market rout when tightening resumes. To that end, it slashed its own forecast to match the setting investors were comfortable with pre-liftoff and seems intent on allowing upbeat US economic data – which has been outperforming relative to forecasts since mid-February – to drive a return there in the priced-in outlook. This will presumably establish realignment allowing for a smooth hike in June.
A critical component to this strategy is the reaction function connecting strong US data and rate hike perceptions. That link breaks down if investors believe external problems are already damaging the outlook. Yellen has already pushed back against this and the Minutes release is another opportunity to do so. If the document stresses that outside threats are being watched but have yet to actually undermine progress toward policy objectives, markets may get the hint and the Aussie may decline as Fed tightening bets rebuild.