Will The Aussie Rally Continue? RBA Minutes

The AUDUSD charged higher last week, becoming one of the top-performing major currencies and reaching a three-month high. Much of the move could be attributed to dollar weakness after the US Treasury increased its long-term bond repurchases. However, the Aussie’s outperformance is notable. The question is whether the recent high signals a turnaround or whether there is still room for further upside.

One reason for Australia’s currency outperformance could be its central bank. The RBA paused its hiking cycle at its last meeting, and the minutes from that decision will be published tomorrow. The meeting appeared more hawkish than expected after Governor Michelle Bullock threatened further hikes if inflation did not remain under control.

A New Appreciation of the Outlook

The RBA is in a delicate situation. Interest rates stand at 4.35% and remain restrictive by most economists’ estimates. This means the central bank could be near the end of its hiking cycle. However, inflation has not returned to target, and the recent energy price surge could keep inflationary pressures in place.

This means the RBA might try to “jawbone” the market into compliance.

The conventional theory is that inflation can be controlled if markets believe the central bank will act to prevent prices from rising. A central bank can therefore hold the line on inflation without raising rates if it convinces markets that it remains willing to hike. That could explain Bullock’s strong rhetoric.

However, the minutes may not reflect the same stance. Policymakers could discuss factors that would limit the need for higher rates. Therefore, the upcoming minutes could deliver a minor dovish surprise and give AUDUSD a pause.

The Favorable Rate Position

A pause does not necessarily mean a change in direction. Australian debt offers a higher yield than US debt as long as current inflation trends remain stable and the Fed does not raise rates.

If the Australian economy remains relatively strong while the US economy cools, the fundamentals point towards further upside for AUDUSD.

There are, however, several conditions behind this outlook. The risks remain on both sides of the currency pair.

Wednesday’s monthly CPI release could play a role, even though markets still consider the quarterly figure more important. July Australian inflation is projected to cool to 3.2% from 3.8% a month earlier. Meanwhile, the RBA’s preferred measure, the trimmed mean, is projected to tick down to 3.5% from 3.6% in June.

What the Market Is Looking For

A significant result against expectations could surprise the market and weaken the Aussie. A substantial upside surprise might initially support the currency. However, investors could become increasingly concerned about economic performance if the RBA is likely to hike again. This could cause the gains to fade quickly.

Cooler inflation would likely strengthen expectations that the RBA will not hike, particularly if the minutes also take a dovish tone. That could weigh on the currency unless upcoming US data also disappoints. In that case, weaker US data could put a floor under AUDUSD.