The Reserve Bank o Australia (RBA) released its latest Statement on Monetary Policy on November 15, 2013. As usual, I read through the tome with a specific focus on understanding any implications for the Australian dollar (NYSEARCA:FXA). I present below the snippets that I found most interesting along with a little of my own editorial.
The RBA once again blames some of the appreciation of the Australian dollar on the Federal Reserve's failure to carry through on its threats to start tapering bond purchases:
Following the depreciation of the Australian dollar through to early August, the exchange rate was relatively stable until the announcement by the Federal Reserve and the subsequent reassessment by markets of the likely path of US monetary policy. This change in view, along with some more positive Chinese data, saw the Australian dollar appreciate…
Most commentators now expect the Federal Reserve to begin reducing asset purchases at its March meeting, which would be the first chaired by Janet Yellen (subject to Senate confirmation).
The recognition that the Fed is not likely to taper until next March means that the RBA is also likely not expecting the Australian dollar to depreciate much in coming months (all else being equal).
The housing market has experienced strong price appreciation this year and is quite robust in most areas of the country. Highly accommodative monetary policy has had its clearest impact in this part of the economy. This strength in housing lowers the odds that the RBA will cut rates further in the near-term without some fresh urgency to do so…(emphasis mine):
Meanwhile, conditions in the established housing market have continued to strengthen. Nationally, dwelling prices are now above their late 2010 peak, housing turnover and loan approvals have picked up noticeably over recent months, auction clearance rates remain high, and surveys suggest that households are more optimistic about the housing market. Improved conditions in the established housing market are providing an impetus for dwelling investment, which looks likely to maintain its upward trend. Residential building approvals and other forward-looking indicators of activity, such as loan approvals and first home owner grants for new dwellings, have increased noticeably over the past year.
As observed in the U.S., the strength in the housing market has yet to ripple out to the rest of the Australian economy in the form of stronger labor markets. In Australia's case, it is the non-mining sector that is of particular concern. The unemployment rate up to levels last seen in 2003. I suspect this alone is enough to make the RBA want to cut rates. Given unemployment has crept higher as rates have gone lower, the RBA will likely need some patience and a sprinkle of hope that existing rate cuts are just taking a longer time to impact the labor market.
Labour market conditions remain soft. Employment has been little changed since earlier this year, while the unemployment rate has edged higher and the participation rate declined noticeably over that period. At the same time, however, total hours worked have continued to trend higher and more recently there are signs that forward-looking indicators of employment growth may no longer be declining. Nevertheless, indicators of job advertisements and vacancies, as well as surveys of firms' employment intentions, remain consistent with only modest employment growth in the near term. The softening in labour market conditions observed over the past year or so has seen a broad-based decline in wage growth across industries. Some measures of wage growth are around their lowest in a decade…
…the unemployment rate is likely to continue to drift higher for a year or so, but is forecast to decline through 2015 as nonresource activity picks up.
The wage growth metrics are likely alarming the RBA, but it is doubtful rate cuts could impact real wage growth. It is interesting to see the forecast for worsening unemployment for a year before 2015 brings relief. I am assuming this is a recognition that monetary policy is not likely to get any more accommodative in the next year.
Import prices are on the rise thanks to the lower currency. Since import prices dropped persistently prior to these increases, there is really no news here. The RBA also does not expect any rapid change in prices.
Prices of tradable items have increased in each of the past two quarters, following a significant decline over the past few years in response to the earlier appreciation of the exchange rate and strong competitive pressures. The exchange rate depreciation since earlier this year has been pushing up import prices, although historical experience would suggest that it is unlikely to have had much effect on most consumer prices as yet; that is expected to occur gradually over the coming quarters.
Putting it all together, the RBA had to downgrade slightly the forecast for the Australian economy. The RBA cited mining investment which "… might decline more than was previously anticipated" as well as the recent strengthening in the Australian dollar which will constrain the traded good sector more than expected. On the positive side, the RBA is expecting lower rates to eventually have a constructive impact on the economy. The RBA is also looking ahead to better growth prospects for Australia's trading partners:
GDP growth is now expected to remain below trend through next year, before picking up through 2015. The forecast for growth to pick up about a year from now is based on the stimulatory effect of low interest rates, the expectation that growth in Australia's trading partners will be close to, if not above, average, further strong population growth and the need to add to the capital stock after a long period of subdued investment (outside of the resources sector)…
Overall, the outlook for below-trend growth over the coming year reflects the substantial fall in mining investment, planned fiscal restraint and the still high level of the Australian dollar.
When the RBA talked directly about the path of the exchange rate, I was VERY surprised to find that the RBA now concludes that the terms of trade will only decline "modestly." Prior to this, I had understood an expectation of a rapid decline in the terms of trade that necessitated an urgent move to cut rates. The immediate implication of a relatively stable exchange rate is consistent with my conclusions above. In the quote below, the RBA does makes a point to note catalysts for driving the currency lower and why Australia needs a lower currency.
The path of the exchange rate is also a significant source of uncertainty for the domestic economy…With the terms of trade forecast to decline only modestly over the coming years, there is some chance that the exchange rate will remain around current levels over the forecast horizon. However, lower capital inflows associated with the decline in mining investment could act to reduce the exchange rate, as could a reduction in stimulatory monetary settings in large economies. A lower exchange rate is likely to be needed to achieve balanced growth in the economy. A lower exchange rate, if it came about, would also see growth strengthening sooner than forecast and place some upward pressure on inflation for a time.
I was very comfortable with my conclusion that the RBA would stand pat of rates and that the exchange rate is just as likely to stabilize as any other scenario, until this seemingly contradictory statement:
At the meetings since August, the Board judged that given the substantial degree of monetary policy stimulus that had already been put in place, it was appropriate to hold the cash rate steady, but not to close off the possibility of reducing it further, should that be needed to support economic activity consistent with the inflation target.
In my opinion, the statements from the meetings since August said nothing about a residual possibility for rate cuts. Instead, the statements were completely devoid of any proclamation on the future possibilities for rate cuts (I covered this in earlier posts). The RBA Rate Tracker has relatively consistently predicted just a 9% chance of a rate cut in the December RBA meeting.
So, this surprising snippet aside, I am currently expecting the Australian dollar to drift up and down largely without direction. These movements will give bears and bulls plenty of trading opportunities.
This week's trading opportunity is likely bearish against the Australian dollar. This week features two important events that could impact the Australian dollar. The minutes from the last RBA meeting are released on Monday evening (Tuesday morning Australia time) where I will be looking for commentary intended to reaffirm the RBA's desire for a lower currency. More importantly, Governor Stevens will speak very early Thursday morning. All ears and eyes will be trained for language intended to grease skids for the Australian dollar. Ahead of each event, I intend to load up short on AUD/USD.
The Australian dollar made a bearish breakdown below its 50-day moving average against the U.S. dollar, but follow-through has been weak
Be careful out there!
Additional disclosure: In forex, I am net long the Australian dollar.