RBA Debelle’s Comments May Have Killed the AUD/USD Rally

Bullish Australian Dollar investors held a great party last week, but as the saying goes, “Every party needs a pooper, that’s why we invited you”. That “you” was Reserve Bank of Australia (RBA) deputy governor Guy Debelle. I really don’t think he was invited to the party, but if I’m right about the market, I think investors are going to wish he hadn’t crashed their party.

Early last week, the Australian Dollar rallied like it was set on fire after the minutes of the RBA monetary policy meeting on July 4 said the central bank now estimates the “neutral” official cash rate to be 3.5 percent, a full 200 basis points above where the cash rate is now.

What this effectively means is that the RBA thinks it can raise its cash rate, currently sitting at a record low of 1.5 percent, without curtailing economic growth.

Investors drove the Australian Dollar to a multi-year high last week because they interpreted the inclusion of the new estimate as a strong sign that central bank sentiment shifted to “hawkish”, since RBA watchers felt it was highly unusual for the central bank to discuss the “neutral” rate at a policy meeting.

The release of the minutes, garnered a two-sided response from analysts, but the action of traders clearly indicated that they thought the news was bullish.

Bullish Support

On the bullish side, economist Stephen Koukoulas described the language of the minutes as “aggressive”. James Glynn, senior economics reporter at the Wall Street Journal, described the minutes as “hawkish”.

Bearish Arguments

In addition to the bullish interpretation of the minutes, there were skeptics. Sally Auld, economist at JP Morgan, said the bank’s discussion of the neutral rate was unlikely to be “interpreted as some sort of signal”.

The RBA also noted there was “significant uncertainty” around estimates of the neutral rate.

Additionally, the RBA minutes explicitly said that “holding the accommodative stance of monetary policy unchanged” would be “consistent with sustainable growth in the economy and achieving the inflation target over time”.

Another reason some analysts doubted the RBA’s intentions was that it said “developments in the labor and housing markets continued to warrant careful monitoring”.

Finally, I think the main reason why the news may have been misinterpreted is that the RBA minutes said that an “appreciating exchange rate would complicate” Australia’s economic growth.

Despite the mixed reaction from analysts, short sellers were scared enough to cover aggressively and speculative buyers thought the news meant a rate hike was coming sooner than expected. The combination of these two factors drove the AUD/USD to .7988, or its highest level since the week-ending May 22, 2015.

RBA Reaction to Rally

The euphoric buying came to a screeching halt on Friday after the RBA attempted to cool down speculation that this month’s minutes signaled a near-future rate hike.

During a speech at a business lunch in Adelaide, RBA deputy governor Guy Debelle said:  “No significance should be read into the fact the neutral rate was discussed at this particular meeting.” This comment immediately dropped the AUD/USD below .7900.

Debelle further added, “The policy rates in both the U.S. and Canada still remain below that in Australia.”

Finally, Debelle said, “Ultimately, in Australia, as is the case elsewhere, policy rates are set at the level assessed to be appropriate to achieve the domestic policy objective.”

Opinion

Although I believe the AUD/USD will eventually revisit the .8000 area, it may spend some time trading lower this week on the heels of the dovish comments from RBA deputy governor Debelle. His comments were strong enough to drive the Forex pair into .7874, which is a little more than 50% of the rally triggered by the RBA minutes.

If the market has absorbed the dovish comments then the AUD/USD could straddle the 50% level at .7887 throughout the week. If traders decide the rally was too much, too fast the selling may continue until the Forex pair completes a 50% break of the rally from .7571 to .7988. This target is .7780.

If traders decide to shrug off Debelle’s comments and choose to focus on the weakness in the U.S. Dollar, better Chinese growth, stronger exports and widening interest rate differentials then the AUD/USD could rebound enough to challenge .8000 and beyond this week.