RBA: Market response to June rate decision - Westpac

Analysts at Westpac point out that as was widely anticipated, the RBA left policy unchanged with the now very standard guidance on the A$ that “an appreciating exchange rate would complicate this adjustment” also left untouched.

Key Quotes

“The A$ did pop modestly higher on the outcome, unwinding the weakness seen earlier in the day on the disappointing net export contribution to Q1 GDP. One factor that may have helped the currency was reference to “economic growth is still expected to increase gradually over the next couple of years to a little above 3 per cent” despite “quarter-to-quarter variation in the growth figures” suggesting the RBA is looking through what could be a soft outcome tomorrow.”

“We see the A$ as being fairly priced at the moment, though with the Fed set to raise rates next week and commodity prices expected to weaken as we move through the end of the year, strength into the 0.75/0.7550 region is seen as a sell opportunity.”

“Rates Perspective

Heading into the announcement, we viewed it as unlikely that the RBA rhetoric would be sufficiently different to produce a valuation shift in Australian bonds.  That was indeed the case. However, those expecting bond prices to drift off as a result would have been disappointed. That is because the more important number, 1Q2017 GDP is due for release tomorrow and  both 3yr and 10yr bonds had rallied on today’s earlier data, which pointed to a weaker than consensus outcome tomorrow.

3yr valuations are such that, in order for them to sustain current levels or rally significantly further, market pricing for an RBA rate cut in 2017 would need to increase toward a 50/50 chance at a minimum. The market currently assigns a 20-25% chance to such a renewal of the easing cycle. With the RBA acknowledging a weaker than expected March quarter growth profile in its Statement, but reiterating its improved growth profile beyond that, it puts even more emphasis on tomorrow’s outcome as key to medium term valuations, especially at the short end of the curve.

For now, we maintain our view that 3yr bonds are overvalued, that the curve, while led directionally by the long end on large outright shifts, will remain tightly range-bound for now (although over time we have a flattening bias), and that any AU relative underperformance from a cross market perspective is likely to be short-lived.”