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“While financial markets keep feasting on the global liquidity glut, there is a subtle but undeniable shift underway in the central bank community towards eyeing not only the end of easing, but the beginning of tightening. To be sure, our central bank watchers expect the Fed, the ECB and the Bank of England to start nudging rates higher only from around the middle of next year, and the Bank of Japan to even ease policy further. However, several other G10 and emerging market central banks look set to tighten policy over the next 3-6 months, and it appears likely that the rhetoric from those who will remain on hold over that period becomes gradually more hawkish (less dovish). This combination of action by some and talk by others may well challenge the prevailing post-Jackson Hole and post-G20 consensus that rates in the major economies will remain low for longer.”

                             Joachim Fels

FX Trading – Aussie vs. Oil: A divergence indeed!
Buy the rumor sell the news? The Australian dollar is sharply higher again today against the buck—which is taking on the chin once again. Traders are jumping all over the expectation (rumor) that Australia’s central bank—the Reserve Bank of Australia—is going to hike interest rates by 25 basis points when they meet tomorrow. That will put the RBA cash rate at 3.25%, towering over the rest of the major currency central bank rates. Adding to the chart is the fact that Australia’s economy seems to be growing faster than its major competitors too. But, there is an interesting divergence developing between Aussie growth expectations and oil prices—the AUDUSD and Oil price series were tightly correlated till recently—what does it mean?

AUDUSD vs. Oil Daily: (Chart next page)

  1. It may not mean anything. Correlations change. No directional probability can be discerned from the supposed past correlation.
  2. It may mean the Aussie is so attractive based on growth (thanks to its neighbor China) and yield that it’s natural for this series to diverge, especially given that oil demand may be subdued because US and Europe are positioned for a low-growth recovery at best.
  3. It may mean the Aussie dollar is way ahead of itself and due for a major correction as oil prices are telling us recovery ain’t all it’s cracked up to be; if China were really blowing and going oil prices would be higher; and a decline in liquidity at the margin as the central banks rein in some of the massive liquidity pool could have financial market consequences.

At the moment, the consensus choice we think is Number 2 above—attractive on growth and yield. We could find out soon.