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The Australian central bank's attempts to talk down its currency have backfired as markets have pushed up both borrowing costs and the dollar on a view its easing cycle may be over.
The Reserve Bank of Australia (RBA) would desperately like to see the Australian dollar much lower to help the country cope as a decade-long mining boom crests. That is a major reason it chopped interest rates to a record low of 2.5% last month.
And it concluded its September policy meeting this week with another plea for the dollar to fall further to help "rebalance" the economy.
Missing from its statement, however, was an explicit acknowledgement that there was still scope to cut rates further if needed, given a benign inflation outlook.
The accent on the currency instead of rates led investors to suspect that the RBA had shifted toward a more neutral policy stance, and even perhaps that it was done easing altogether.
The result was almost certainly not what the central bank intended. The market rushed to price out any chance of rate cuts and now is even hinting at a future hike, which in turn has shoved the Aussie sharply higher.
"In attempting to talk down the Aussie, the bank has inadvertently strengthened it by allowing the market to reduce the forward interest-rate discount that had assumed further RBA rate cuts," explains Sean Keane of Triple T Consulting, which works for Credit Suisse.
The sea change was evident in overnight indexed swaps, which essentially map out where the market thinks the cash rate will be over time.
Having started the week pricing in cuts out over the next 12 months, they swung sharply in the wake the RBA meeting and now imply rates could be 7 basis points higher in a year.
This is the first time the curve has priced in any tightening since the middle of 2011. The market is hardly infallible -- the RBA has slashed rates by 125 basis points since mid-2011 -- but it has had a real and immediate impact on borrowing costs.
"The RBA's got itself into a box here," said Brian Redican, a senior economist at Macquarie Bank. "It keeps saying that a lower dollar would help do the easing for it. But all the market hears is 'no more rate cuts'."
"One escape route would be just to pledge to do whatever it takes on rates to get the economy moving. That would force the market to price cuts back in, and then the dollar would fall."
NOT WANTED
Yields on two-year government debt have climbed 28 basis points just this week to 2.87%, a long way from a low of 2.35% seen in early August.
Yields on 10-year paper have vaulted to 18-month highs at 4.15%, though part of that was a reaction to a spike in US Treasury yields.
The swing in rate expectations in turn drove the Aussie up over two US cents for the week to $0.9126. In trade-weighted terms it is up 2.6%, with the rally all the greater because speculators had been heavily short of the currency as part of a wager on turmoil in emerging markets.
The break higher snapped major resistance levels and has some chart watchers excited.
The technical team at CitiFX for instance has an initial target of $0.9575 and a possible extension to $0.9900.
"The pair has broken good resistance -- 55 day moving average (MA) and trend line -- and is setting up for a potential double bottom which would target $0.9575. The stretched 55-200 day MA gap dynamic further supports a move higher."
Such a rise would be precisely the opposite of what the RBA has been trying to achieve, and could well force it to cut rates again even if it would rather not.
"The most effective way for the RBA to restore the status quo ante, and to send the AUD back lower, would be to encourage easier rate policy expectations once again," said Keane at Triple T.
"The recent moves in both currency and rate markets are not at all what a below-trend, imbalanced economy needs at this time of the cycle."
