It has been another busy week in financial markets with key announcements out of the US regarding interest rates, as well as new developments in Brexit. As a result, the AUD witnessed some mild volatility. With this in mind, one Aussie dollar will buy you:
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The biggest news out of the US this week was the apparent abandonment of the Federal Reserve Bank’s plan to increase interest rates in the States. This is quite different from the rhetoric they were providing in September last year, where further interest rate increases were seemingly on the horizon. The Fed now sees no further tightening to monetary policy this year.
President Trump will be taking this as a win, as he has previously made his disapproval of the Fed’s interest rate increases quite obvious.
The Fed now sees signs of an economic slowdown that would warrant a pause on their current tightening of the balance sheet
. They have downgraded US Gross Domestic Product, unemployment and inflation forecasts. In addition to this, they see the current interest rate level of 2.25% - 2.50% remaining for the foreseeable future.
This is good news for the Australian dollar, and Aussie travellers, as it means the rate differential between the two countries won’t increase further. This potentially prevents more investors choosing to put money towards the US, which would put upward pressure on the value of the USD against the AUD.
The Fed also said that starting in May 2019 they would slow their monthly reduction in the balance sheet by as much as $50 billion before stopping altogether in September. The combination of signalling no further rate hikes, downgrading economic forecasts and halting the unwinding of the balance sheet all seem to indicate that the Fed sees a few storm clouds on the horizon for the global economy.
This interest rate differential still has the potential to widen though, as the Reserve Bank of Australia (RBA) may decide to cut interest rates in Australia to make up for relatively weak economic data as of late.
Should it go ahead, this decision may come as a surprise considering this week’s release of employment figures showed the unemployment rate fell to an eight-year low of 4.9%. However, this low was mainly driven by a drop in the participation rate; the number of people actually in full-time work dropped for the third time in four months.
While the RBA kept rates on hold this month, a number of economists expect a rate cut (or maybe two) this year. The employment figures released this week have not changed the RBA’s stance on this matter.
Overnight the European Union met, and all 27 member countries signed off on a final statement regarding Brexit
. This comes after British MPs voted last week to extend the Brexit deadline beyond March 29, 2019, as they have yet to approve any form of withdrawal agreement.
The EU has stated that should British Prime Minister Theresa May not win approval from MPs for her current withdrawal agreement (an agreement which has already been rejected twice), the UK will be given until April 12 to decide if they are participating in European Parliament elections that start on May 23rd, 2019.
Alternatively, the EU will grant an extension until May 22 if the Withdrawal Agreement is approved by MPs next week. Despite May’s work to get MPs on her side in the next few days, it seems highly unlikely that this deal will be approved.
Furthermore, despite British MPs voting last week in favour of avoiding a no-deal situation, if an agreement is not reached next week, the chances of a no-deal increase significantly. This is likely not in the best interest of the UK, Europe and the wider global economy. In particular, Australia’s economy could feel the negative flow-on effects. This could potentially put long term downward pressure on the value of the AUD.
Definitions for those of us playing at home:
Interest Rate Differential (IRD)
Interest rate differentials essentially measure the difference in interest rates between two securities, or countries. Foreign exchange traders use IRDs when forecasting foreign exchange rates.
Unwinding the balance sheet
After the Global Financial Crisis in 2007, the Fed purchased a huge amount of long term assets (we’re talking trillions of dollars) to rapidly increase the value of their balance sheet in hope of putting downward pressure on long term interest rates. This inflated the size of the US balance sheet.
Since then, assets have begun to mature and the Fed has continued to purchase new ones, essentially replacing them, to maintain the size and composition of the balance sheet. This occurred for about three years until the US economy moved more in line with the Fed’s targets. From here, the Fed wanted to start reducing the huge balance sheet by very slowly letting older bonds mature by not reinvesting.
This notion started towards the end of 2017. However, now the US economy is apparently not as fine and dandy as thought (compared with late last year), and so the Fed has started slowing interest rate increases. As a result, there is some talk of slowing (if not stopping) the current runoff from the balance sheet.
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All rates are quoted from the Travel Money Oz website and are valid as of 22 March 2019