On July 3rd, Stevens provided an "Economic Update" at The Econometric Society Australasian Meeting and the Australian Conference of Economists at the University of Tasmania. In this speech, Stevens took direct aim at the Australian dollar AND at the way in which the RBA talks about the exchange rate. It was a fascinating moment of transparency:
"We have tried to avoid frequent and large language shifts about the exchange rate. It can vary enough from month to month that we risk chasing our tails if we seek to engage too actively in 'jawboning' each month."
From here, perhaps ironically, Stevens dove directly into jawboning on the Australian dollar. Stevens made it abundantly clear that the Australian dollar is not just too high, it is extremely over-valued. He provided a litany of reasons for this belief:
"But lest there be any uncertainty about this, let me be clear, again, that the exchange rate remains high by historical standards. There is little doubt that significant parts of the trade-exposed sectors still find it quite 'uncomfortable': it continues to exert acute pressure for cost containment, productivity improvement and business model change. When judged against current and likely future trends in the terms of trade, and Australia's still high costs of production relative to those elsewhere in the world, most measurements would say it is overvalued, and not by just a few cents."
Stevens went on to suggest that the zero interest rate policies (ZIRP) of major central banks are partly to blame for the inflation of the Australian dollar, but also warned market participants that this was no reason to remain complacent on the value of the currency. Indeed, his warning could not be more direct or more ominous (emphasis mine):
"…we think that investors are under-estimating the likelihood of a significant fall in the Australian dollar at some point."
Combine this stern warning with a surprisingly large plunge in Australia's trade balance, and we get a market that actually seems to have taken heed. Whether the Australian dollar sustains this pullback remains to be seen of course. After all, Stevens did not make the more convincing threat that the central bank would take direct action to devalue the currency.
The Australian dollar looks like it has finally peaked against the U.S. dollar. However, the recent recovery from 2014′s lows is well intact.Source: FreeStockCharts.com
The RBA could use interest rate cuts to try to devalue the Australian dollar, but Stevens pointed out that the last rate cut cycle did not have the expected impact on the exchange rate. The RBA could also downplay the strength of the economy to dissuade currency traders from thinking the currency represents a good value, but Stevens largely avoided this tact beyond the stern warning he provided on the impact of the higher rate.
Stevens began the economic portion of the speech by downplaying the recent strength in the GDP, suggesting that it was driven by an unsustainable increase in resource exports. Perhaps ominously, he went on to note that the RBA still has room to cut interest rates even as current policy is accommodative on a historic scale and should "…be supporting demand for some time yet." However, Stevens constructed the broad discussion of current economic conditions to set up the rationale for leaving interest rates unchanged at 2.5% for almost a year.
In doing so, Stevens recognized that "…since markets and media commentators find the idea of masterly inaction neither appealing nor interesting, this has put more focus on communication." The RBA has responded by taking great care in its communication, and Stevens methodically stepped through the evolution of the RBA's communication tactics during this time. In particular, Stevens took a special jab at folks who had been calling for the RBA to start tightening monetary policy (emphasis mine):
"Although this shift in language was quite gradual, the problem we can sometimes have in such periods is that people may react by thinking that, if the Bank is not thinking about easing, then it must be thinking about tightening. But we were not contemplating tightening. In fact, the conclusion we had reached was that we might be on the brink of sitting still for some time. That is why we adopted language about 'stability' in interest rates, the intended effect of which was to be clear to people that we did not think that higher interest rates were imminent. That has not stopped people from opining about the timing of possible future increases - or, indeed, decreases. That's what makes a market - people have differing views, for various reasons."
I think it goes without saying that the RBA has absolutely no interest in hiking interest rates in an environment where it feels the currency is extremely over-valued. Note that in recent days expectations for a rate cut at the August RBA meeting on monetary policy have nudged slightly higher albeit still low.
A slight increase in the odds for a rate cut from next to "no way"Source: The August 2014 RBA Rate Tracker from the Australian Stock Exchange
Most importantly, Stevens gave very explicit instructions for how to monitor and interpret RBA communications in the future. We onlookers need to consider the full package:
"It should go without saying that those seeking to understand our thinking should, in any event, look not just at the wording in the post-Board statement, nor just that in the minutes, but also at the whole analysis of the economy and the outlook in the regular Statement on Monetary Policy."
So, this speech from Stevens was apparently an effort to deliver an extra level of transparency on policy, strategy, and tactics. It has helped firm up my approach to maintain a core short position on the Australian dollar even as shorter-term events deliver good opportunities to bet on the Australian dollar especially against the euro and the Japanese yen.
Be careful out there!
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: In forex, I am net short the Australian dollar