The RBA Meeting Minutes released Monday signaled that although the AUD (FXA) is trading at a higher exchange rate than expected given the worsening terms of trade, there is no urge to enact further accommodative monetary policy at this juncture. In fact, the minutes suggest that the RBA is willing to wait patiently while the 175 basis points of cuts that have been enacted since late 2011 work their way through the economy. From the statement:
Noting that monetary policy was already accommodative as a result of the substantial easing of policy over the past 15 months, and that this stimulus was continuing to work its way through the economy, the Board judged that it was prudent to leave the cash rate unchanged at this meeting.
With regards to the Yen's weakening, there was one paragraph dedicated to the subject, which was also mentioned in the previous meetings minutes of December 4th. In December 4th minutes, the RBA noted the 3% depreciation of the Yen relative to USD; in Monday's minutes the RBA credited the rhetoric of Japanese leaders to the weakening of the Yen:
The Japanese election and statements by Japanese politicians had contributed to a significant depreciation of the yen since mid November. With the yen depreciating sharply, officials from an increasing number of countries had expressed concerns about the strength of their currencies. The Australian dollar had appreciated by 13 per cent against the yen since mid November, but there had been little change on a trade-weighted basis and against the US dollar. Members observed that the Australian dollar remained at a high level by historical standards.
Although the 13% appreciation of the AUD was explicitly mentioned, earlier in the statement the board expressed its approval of developments in financial markets, indicating that they are unlikely to take any actions internationally to stem the fall of the Yen:
Conditions in financial markets had continued to improve over the past couple of months, with sentiment supported by the partial resolution of the fiscal situation in the United States, approval of the revised Greek bailout package in December, policy developments in Japan and generally better-than-expected economic data globally.
The markets have digested the publishing of the minutes with a strengthening of the AUD, continuing an uptrend that has been in place since Sunday:
Although this is part of a larger trend downward over the past month:
Terms of Trade Improving While Exchange Rate Trends Down
Prior to releasing their statement on February 5th, the Terms of Trade came in at -$427 million, better than the expected -$800 million, which along with positive Housing Price Index data supported the holding of rates at 3%.
The current high price of the AUD appears to be having an effect on the terms of trade, with Australia moving from a large trade balance surplus in 2010 and 2011 to a deficit in 2012. As would be expected, there was a lag in the worsening in the terms of trade to the higher AUD, also known as the "J Curve Effect", which essentially states that exports and imports take time to adjust in the face of exchange rate changes due to the time it takes for businesses to adjust.
The chart below charts the exchange rate (blue region) versus the terms of trade (yellow line):
Unemployment Continues to Drift Up, Along With Part Time Employment
The RBA statement noted the gradual drift up in the unemployment rate combined with the lower participation rate and average hours worked:
The unemployment rate had drifted up gradually over 2012, to be 5.4 per cent in December. Members noted that, over the same period, the labour force participation rate had declined a little and average hours worked were a little lower. Total employment had grown moderately in the second half of 2012, despite some decline in employment in mining and business services. Job vacancies and other forward-looking indicators had continued to soften, but remained consistent with modest employment growth in the months ahead.
This will be a key metric to watch, as if unemployment continues to worsen, it could act as a catalyst for another cut of the interest rate or other accommodative measures.
In addition, part time gains have been outstripping full time gains, which is another cause for concern and why the AUD fell during the last employment report even though 10.4k jobs were created versus the 5k expected. Below is a chart with AUDUSD exchange rate (blue shaded region), participation rate (yellow line), full time employment (pink line) and part time employment (green line). The full time and part time lines have been normalized for comparison purposes.
The Bottom Line
The minutes from the February 5th RBA meeting are surprisingly upbeat in the face of continuing worsening terms of trade and employment numbers. It appears the RBA is prepared to be patient while the full impact of the interest rate cuts of 175 basis points made over the past 15 months work their way through the economy. In addition, there was nothing in the minutes to suggest that the RBA was overly concerned with the weakening of the Yen or the prospects for an international currency war.
Therefore, based on the minutes of this past meeting, it appears the 3% cash rate will remain for the immediate future. Keep an eye on the terms of trade and employment numbers though, as a significant change in either of these two factors could act as a catalyst for further action by the RBA.
Disclosure: I am short FXA.