Stevens Passes On Jawboning The Australian Dollar And Sticks To A Familiar Script

Includes: CROC, FXA, GDAY, UUP
by: Dr. Duru


FXA has remained resilient in recent weeks.

RBA Governor Stevens chose not to lean directly against this rally in a recent speech.

Stevens reminded the audience that the currency "should" head lower based on declining terms of trade.

The Australian dollar (NYSEARCA:FXA) has been incredibly resilient in recent weeks. Weak economic data from China and concerns about excessive debt in the Chinese economy have barely dented the recent momentum. As of the time of this writing, the Australian dollar is printing a potentially important breakout above its 200-day moving average (DMA).

The Australian dollar breaks out as part of a 2-month recovery from multi-year lows against the U.S. dollar


As the chart above shows it was only three months ago when Glenn Stevens, the governor of the Reserve Bank of Australia (RBA), suggested that 0.85 is a fair target for the Australian dollar versus the U.S. dollar. With this context, I half-expected Stevens to treat his Wednesday speech to the 17th Annual Credit Suisse Asian Investment Conference as another opportunity to tease the market into doing the RBA's bidding. Instead, Stevens seemed to take great pains to avoid jawboning as he sang the praises of the Australian economy. At one point, Stevens even suggested that he is not (no longer?) interested in trying to tweak the exchange rate as a tool for economic growth:

Strong long-run growth won't be achieved in any country simply by manipulating interest rates (or, for that matter, exchange rates).

There were only two moments when Stevens even bothered to question the market's pricing mechanism for exchange rates. The first was an oblique remark suggesting that the U.S. dollar (NYSEARCA:UUP) is under-valued (and presumably AUD/USD over-valued):

…the monetary policy trajectories of the major currency areas could diverge, and increasingly so, over the next couple of years. One interesting question is how fully this possibility is reflected in major exchange rates.

Stevens made this observation in reference to the high likelihood that the Bank of Japan (BoJ) and the European Central Bank (ECB) will be conducting further easing while the U.S. is tapering quantitative easing and heading toward higher interest rates.

The second moment for questioning the market came during the Q&A period. The second question from the audience directly asked Stevens about the exchange rate and whether 90 is the official "line in the sand."

Stevens immediately disabused the audience from the notion that a line in the sand actually exists. He then went on to note how the RBA felt it made sense for the Australian dollar to rise along with soaring terms of trade. On the other side of the peak in the terms of trade, the RBA was surprised by how long it took for the Australian dollar to come back down ("happily enough the currency is now well down off its peak"). Since the RBA projects further declines in the terms of trade, it also expects that the Australian dollar should accompany the terms of trade to lower levels. Stevens reminded the audience that the RBA has been quite "transparent" in making its position clear. Given the market's response so far has been to continue pushing the Australian dollar higher, it seems the market has yet to buy into these complementary dynamics.

During the prepared remarks Stevens reminded the audience that the lower exchange rate has helped the Australian economy and supports a relatively optimistic outlook:

It is important to stress that this outlook is, obviously, a balance between the large negative force of declining mining investment and, working the other way, the likely pick up in some other areas of demand helped by very low interest rates, improved confidence and so on, as well as higher resource shipments. The lower exchange rate since last April and the improved economic conditions overseas also help…

…absent continually rising profit margins on the part of businesses, we don't see the conditions for persistently higher consumer price inflation, even though tradable goods prices are expected to rise due to the lower exchange rate.

Stevens clearly does not expect the exchange rate to continue rallying although he acknowledges that "…as always, the exchange rate is a source of significant uncertainty."

Ever since AUD/USD first vacillated around the 0.90 level, I decided to just stick with the longer-term bearish bias on the Australian dollar. My fine-tuning is now reserved for short-term trades that hedge against the stubborn rise in the currency. As the chart above shows, the Australian dollar has taken a zigzag path higher that has delivered plenty of short-term trading opportunities (for bears and bulls). These opportunities may diminish in number if the currency continues to stretch higher in breakout formation. The current run-up has entered its sixth day, the longest such streak in over a year (AUD/USD rose five straight days off the late August, 2013 bottom).

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am net short the Australian dollar