RBA Unlikely to Cut Interest Rates, Australian Dollar Keeps Rising

It’s nearly unthinkable that the Reserve Bank of Australia would cut interest rates at tomorrow’s meetings. But let’s think about it anyway and see where it takes us.

The cash rate set by the bank is 6.5%. That’s one hundred and seventy five basis points (1.75%) above the Fed Funds rate in America. The cost of money is higher in Australia. That yawning gap is the reason the Australian dollar has nearly crested 88 cents against the greenback in the last few days.

The local dollar is not the only commodity-currency setting record highs. Canada’s dollar (CAD) —the Loonie—reached a 31-year high. The Canadian dollar now buys you one hundred and one US cents. Forget parity. The Loonie has moved into superiority.

How is too high? Is there a point at which commodity currencies like the Australian, Kiwi and Canadian dollars are TOO strong? At what point are exporters hurt by the decreasing value of US-dollar denominated commodity sales? Hmmn.

“The yield differential is still in favour of the kiwi,” ANZ currency trader Tony Allen told Bloomberg. “`How can you sell it when growth is still as strong as it is and the US dollar down where it is?” And why would you want to sell it anyway? “The Japanese are still trying to get their money offshore and the high yielders like New Zealand are looking good,” the wise Mr. Allen added. “The US dollar is under some real pressure, why would you buy it?”

Assuming this is not a rhetorical question, we are hard pressed to come up with a good answer. The only real answer is, “Because you have to if you are trading commodities”. The dollar’s status as the world’s reserve currency guarantees there will be demand for it in the trading of financial assets and commodities. But it’s just that status that’s coming unravelled before our very eyes.

For now, central bankers around the world have declined to follow the Fed and cut rates. If Bernanke wants to blow a hole in the keel of the good ship USA and then lock himself in the bridge while it goes down, he may not have a lot of company. We can’t help but think of that scene in James Cameron’s “Titanic” when Captain Edward J. Smith stands alone at the wheel as the weight of the North Atlantic comes crashing down around him from all directions—only we imagine the bearded Ben Bernanke in his place, figuratively drowning in a sea of green paper.

Here in Australia, with tight labour markets, rising food prices, and strong credit growth, it seems highly unlikely the Reserve Bank would pull a stunner and cut rates. And the futures markets are already anticipating another US Fed rate cut later this year. That anticipation may account for some of the greenback’s weakness and hence the Aussie dollar’s recent strength.

Dan Denning
The Daily Reckoning Australia

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