Australia central bank likely to cut rate on strong dollar

BT Investment Management is betting that an overvalued currency will shake the Reserve Bank of Australia’s confidence in the economy and force it to slash interest rates.
The Australian dollar has already risen more than 3% this year to 75.27 US cents as of 5 pm yesterday in Sydney and could reach 80 cents, according to the fund manager’s Sydney-based head of fixed income Vimal Gor, who helps oversee about A$15bn ($11bn). He reckons the economic drag created by an overly strong Aussie is likely to spur at least half a percentage point of rate cuts from the RBA, which has already reduced the cash rate to a record low 2%.
“We’re just sitting here on a slow glide path lower in terms of growth; unfortunately at the same time the currency’s appreciating, which exacerbates the slowdown,” Gor said in an interview last week.
Intermittent RBA rate cuts over more than four years have helped to support Australia’s economy amid a slump in mining investment and a drop in commodity prices. Part of the benefit has come from a weaker currency, a gain that is now being undermined as the Aussie rebounds amid fresh injections of stimulus from Europe to Japan and New Zealand.
While economic indicators haven’t yet been weak enough to prompt further RBA cuts and BT has pushed back its easing forecasts, Gor fully expects the central bank to reduce rates even as governor Glenn Stevens signals his reluctance to budge.
“Certainly the second half of the year looks much more likely than a cut in the first half,” said Gor, who is betting that the front end of the Australian yield curve will flatten and is also implementing his view by using one-year, one-year swaptions.
The BT Wholesale Fixed Interest Fund has delivered an average annual gain of 6.1% over the past five years, outstripping the returns of about 90% of its peers, according to data compiled by Bloomberg.
Gor says he is looking for opportunities to bet on a decline in the Australian dollar, though he predicts that it could climb toward 80 cents in the short-term. The median estimate of analysts polled by Bloomberg is
for a 5.7% drop to 71 by year-end.
“In a world which is searching for higher-yielding assets at the moment, I think Aussie bonds still look OK and the Aussie currency looks OK,” he said. “One or two-year view, I’d definitely be short. But on a two-week to three-month view, I don’t think I want to have a position on it right now.”
Gor said a year ago that the RBA cash rate could drop as low as 1% and he still sees a risk of it falling below 1.5%. While Stevens has kept Australia’s key rate unchanged since last May and expressed a disinclination to go lower, Gor sees the pressures of global “currency wars” forcing the governor’s hand as the European Central Bank and Bank of Japan take their benchmarks deeper into negative territory.
The decision by the US Treasury to criticise the RBA’s commentary on the currency means that so-called jawboning might, at the margin, become a less appealing option for Stevens and that could add to the prospects for interest-rate cuts, Gor said.
“By not lowering interest rates, you hold the currency up higher than it ultimately would be,” said Gor. “I’m pretty sure the RBA would rather the currency wasn’t 10% overvalued.”