The recent Reserve Bank of Australia (RBA) and Bernanke induced fall in the AUD (FXA) has drawn lots of attention. Betting on the end of the commodity supercycle has been a common theme, or perhaps nightmare, in the past few years, seeing that commodity currencies have remained stubbornly high. Is the RBA and Bernanke's latest move likely to send the AUD into a downtrend?
Yes, but don't expect big things to happen in the short run. As a speculator that's been anticipating the end of the commodity supercycle for years, I know how it feels like to see the AUD/USD at 1.00 and imagine it at 0.7 or even 0.6 at some point. But I think there is one salient point many market analysts and participants are missing.
Who's your banker?
The fact remains that foreigners own around 200 billion AUD of Australian government bonds. More importantly, the consensus view is that sovereign wealth funds are major holders. Unfortunately, the evidence on that is circumstantial. In 2011, Robert Nicholl, chief executive of the Australian Office for Financial Management, Australia's debt agency, noted that "There is a lot of interest from foreign central banks in our securities, and that certainly has strengthened up over the last couple of years." In 2012, the same individual suggested that "Central banks and sovereign wealth funds still comprise at least half of potential new investment in our bonds by volume, but there are also a lot of private fund investors looking to get into the Australian market," he said. This is also mentioned by analysts from major Australian banks.
Source: Variant Perception's Report "Australia: The Unlucky Country(direct link to chart instead of report that requires signup)"
It appears sovereign wealth funds have not learned anything from the 2008 Financial Crisis, when they, you know, bought Fannie bonds at yield spreads of 20 bps or less to U.S. Treasuries and panicked in 2008.
Source: The US Financial Crisis: Credit Crunch and Yield Spreads page 12
Moreover, official statistics compiled show that "(Australia) owe[s] the rest of the world 132 per cent of our annual gross domestic product". An Australian institution is likely to think in AUD terms, but a foreign institution is probably more prone to think in USD terms or their own currency. An 8% decline in the AUD in 1 month is not likely to go down well with these creditors.
Back to the Future
Let's take a brief detour into the memoirs of Hank Paulson ("On The Brink"), concerning how he dealt with foreign creditors in 2008. You see, the issue was always on his mind.
|July 2008||"I was concerned that investors had lost faith in Fannie and Freddie. The mortgage giants had lost almost half of their value that week. This worried the debt holders, from U.S. pension funds to foreign governments"|
|"From the moment the GSEs' problems hit the news, Treasury had been getting nervous calls from officials of foreign countries that were invested heavily with Fannie and Freddie"|
|August 2008||Learnt that "Russian officials had made a top-level approach to the Chinese suggesting that together they might sell big chunks of their GSE holdings"|
|In Beijing for Olympics:"It didn't help that my calls home needed to be cryptic... I didn't want any news to leak out about how bad things were going with the GSEs. On the contrary, I was doing my best, in private meetings and dinners, to assure the Chinese that everything would be all right."|
|Sept 2008||"It was important to relay what was going on to the Chinese, who owned a vast quantity of U.S. securities, including hundreds of billions of dollars of GSE debt."I always said we'd live up to our obligations," I reminded Wang(then Vice Premier). "We take them seriously.""You're doing everything you know how to," Wang said, adding that the Chinese would continue to hold their positions."|
|"Initial reaction our seizing control of the two big mortgage companies had encouraged me. Asian and European markets had surged, and Japanese and Chinese central bankers had applauded."|
|Companies used the [money market] funds for their cash management needs, and money poured in from overseas investors-Singaporeans, British, and Chinese-eager to get a little more yield than on straight Treasuries. This kind of money was "hot," likely to flee at the first sign of trouble|
|Heard from their Wall Street sources that a number of Chinese banks were withdrawing large sums from the money market funds.|
|Confirmed reports Chinese had been pulling back. Spoke with central bank governor Zhou Xiaochuan, who emphasized the moves had not been orchestrated by the government but were made by midlevel bureaucrats and various financial institutions doing what they thought was the smart thing. The Chinese leadership would be giving some guidance to these professionals not to pull back from the money markets or from secured lending.|
|Wang (same as above) had a high regard for John Mack and his company. As he knew, CIC was looking at increasing its 9.9 percent stake in Morgan Stanley... But Wang seemed lukewarm and concerned about the safety of any Chinese investment. I knew that CIC had lost heavily on its existing Morgan Stanley holding, and that had been a source of great controversy inside China. ...China was already providing tremendous support to the U.S. by buying and holding Treasuries and GSE securities.|
Source: "On The Brink", certain sentences were paraphrased/omitted
It's pretty clear. Paulson got lots of phone calls from Chinese (and other foreign) creditors and was repeatedly attempting to reassure them. He paid attention to their reaction to U.S. policy actions, scrutinized the money flow and called (or had a staff member call) whenever rumors of outflows appeared.
The Prophetic Stevens
It is not unthinkable that the RBA and Australian Treasury would undergo the same grilling from sovereign investors that figured (wrongly again) that the AUD was a safe haven currency. Sovereign investors would be doubly angered since the RBA was hinting it would do nothing big for months (though there were small amounts of what was reportedly "passive intervention", similar to rumors of shadow intervention in the USDJPY at 78 last autumn). Studies that suggested the AUD was only overvalued by 5%. Or RBA governor Stevens saying this in a parliamentary testimony merely months ago (the original link of which is broken, so we must rely on second-hand quotes, my comments are in parentheses in bold):
"On what the tools would be if you think it is a major overvaluation, I think, in all honesty, the evidence of history is that, if it is overvalued by a long way, it is going to come down sooner or later and the market will bring it down.(If overvalued, market will self-correct) should add that, if that is the case and that starts to happen, my expectation would be that public debate will very quickly swing from fretting about the higher dollar to fretting about a falling one. ( If it does start falling, the public will be complaining about crashing currency. The other tool that may be available is, of course, intervention. I think the truth is that, with the power of the forces at work here, you would need to be pretty confident that it is seriously overvalued (we can't know that) or that the market is behaving in some quite irrational way (or that) before you would launch on large-scale intervention, and we have not done that in this episode (this would take us into uncharted waters!)."
And just a month ago, "Australia's economy is coping well under pressure from the country's strong exchange rate, a central bank official said Wednesday, echoing remarks made the same day by Treasurer Wayne Swan" (source).
Perhaps what ultimately pushed normally conservative central bankers to action was Japan's bold and aggressive QE, which has caused restraint to fall globally. Though I haven't found anything where the RBA fingers Japan directly, Australia's neighbor New Zealand's central bank has: "Further appreciation has occurred partly in response to the announcement of a substantial quantitative easing programme in Japan." (source).
Close But Not Yet
My call is that the RBA and Australian Treasury will at least take foreign sovereign and other institutional creditors in mind (if they are not already getting angry phone calls) and not depreciate the currency (or be perceived of depreciating the currency) too fast. RBA governor Stevens is clearly aware that complaints about an overvalued currency could just as easily, and speedily, turn into worries over a depreciating currency.
For example, today former RBA board member McKibbin noted that "Foreign preference for $A assets is waning","Says more RBA rate cuts would be 'a mistake'" though he does see "more rate cuts coming".
As aforementioned, I believe the commodity supercycle will end at some point, but tactically, I expect consolidation with a slight downward drift in Oceanics currencies (AUD, NZD) for the time being but will be following the situation closely.
The real significance of the RBA move is that safe havens are showing decreasing willingness to remain safe havens and market participants are believing in and reacting to central bank resolve much faster. If, say, the Swiss National Bank announces more measures to devalue the Swiss Franc, it could cause a sharp fall as market participants have learned to jump when the central bank says so from the Yen and AUD experience.