The Fed v RBA

03/04/2018

Fundamentals for interest rates in Australia may be changing.

The RBA announced in April 2018 that the official cash rate is unchanged at 1.50%. The Federal Reserve (The USA equivalent of our RBA) increased its top target cash rate to 1.75%.

This is the first time for eighteen (18) years that the U.S. is above Australia, with further indication that there are more increases to come too.

You have often heard this writer say that this is not a sustainable scenario, perhaps though it means a significant shift in fundamentals.

Historically, investors want a greater return for the additional risk for investing in Australia compared with the US and this is one of the main reasons for the “spread” between the two.

It is again a sign of a more global economy as Australia is seen as shifting its policy making away from its links with the US, and more to the Asian region (China specifically). China has replaced the US as Australia’s main trading partner (by nearly three times the volume) and interest rates are one reflection of this changing landscape.

With no immediate rates increases on the horizon in Australia, many experts are saying the rate differential could be here to stay. The RBA has also been strong in its sentiments recently in saying they policy wouldn’t be driven by international policies.

This hawkish tone is backed up a surprisingly resilient Australian dollar, which given the comparative interest rates remains higher than expected. When it comes to exchange rates, there are many more factors than interest rates at play, including a combination of stronger commodity prices steeling our dollar, along with ongoing deficit concerns for the US economy.

This sentiment and the exchange rate will be tested if the U.S. Cash Rate increases again. Right now, this interest rate policy suits Australia as they would like to see the dollar depreciate a little to breathe live into the Australian economy.

So if this sustains, watch the exchange rate closely.

History has a habit of repeating so I for one will need more convincing that the fundamentals have changed yet.