- Reserve Bank of Australian Governor Glenn Stevens recently laid out the case for a lower Australian dollar.
- Although the trend for the Australian dollar has definitely pointed downward since a 2011 top, the pace of the decline is clearly unsatisfactory.
- The Reserve Bank of Australia appears completely dependent on external events and actors for bringing down the currency.
On exchange rates, I suppose the other point to make is that we in Australia sit here a bit puzzled as to why the Aussie dollar is quite so high. But in Canada, New Zealand and Europe similar questions are being asked about their currencies. The common part there is: how come the US dollar is not higher given that, clearly, the US is recovering fairly well now? Clearly the Fed will be the first major jurisdiction to begin the tightening phase. They will do it very gradually but, nonetheless, they will be way ahead of Japan or Europe. I think a lot of people are surprised that the US dollar is not a bit higher than it is. The Aussie dollar being where it is-and this is the case with these other currencies-is the flip side of that.
- Glenn Stevens, Governor of the Reserve Bank of Australia (RBA) speaking at Australia's House of Representatives Standing Committee on Economics on August 20, 2014.
Governor Stevens made these comments on the heels of the dollar index making an 11-month high, largely thanks to an overdue plunge in the euro (NYSEARCA:FXE) to 11-month lows against the U.S. dollar. He should have been speaking in tones of relief that the long-anticipated rally in the U.S. dollar (NYSEARCA:UUP) finally seems underway. Yet, the Australian dollar (NYSEARCA:FXA) has also been (stubbornly) strong, almost completely masking the benefit from the rising dollar. The CurrencyShares Australian Dollar ETF is still up 4% year-to-date and just off its highs for 2014.
The Australia dollar is off its post-recession high against the U.S. dollar (set in 2011), but 2013′s descent came to an abrupt end in 2014
Stevens admitted that he struggles to explain the resilience of the Australian dollar given "…relative levels of costs adjusted for productivity; the relationship between the real exchange rate and the terms of trade; and even taking account of interest rate differentials and thinking about the fact that the terms of trade have been falling and, quite possibly, will fall further…" He also acknowledged that it is possible that the market knows something that he does not understand, but he ultimately insists that he will be very surprised if his currency stays this high "…over a very long period."
Stevens identifies two primary culprits for the strength of the Australian dollar: 1) the willingness of financial markets to price assets with little consideration for underlying risks, and 2) the lack of readiness of financial markets to price in the reality of higher rates in the U.S. starting sometime mid-2015.
The first point has been discussed nearly ad nauseam by major central banks. For example, the Bank of England's Governor Mark Carney is now very fond of talking about surprisingly low volatility in financial markets. Central banks promise to steer the planet's economies, provide buffers against shocks, and keep rates low and supportive, and wonder why financial markets have gone the way of low volatility and an assumption that the world is relatively low on risk. I wrote in detail on this topic three months ago in "Where Is The Risk? The Ironies And Tensions Between Low Volatility And Accommodative Monetary Policies."
The second point reflects an on-going disbelief that the Fed is ready to raise rates anytime soon. This attitude was on-display as the media-driven hype about the Fed falling behind on inflation swept over the market for a hot moment. The Fed of course does very little to discourage such hand-wringing because it indeed would like to keep rates low for an "extended period." The longer it can delay the market's tendency to price in the future, the better for accommodative rates.
In the end, it seems the RBA is pretty toothless in convincing the market to take down its currency. Stevens hints at the possibility of currency intervention even as he makes it clear such a move would be useless against "...the pretty big wall of money coming in." The RBA is instead completely reliant on external events whether it be a market panic over China, Australia's most important trading partner, or a rush to get ahead of a tightening cycle by the Federal Reserve. Neither event is discernible over the horizon. Regardless, the overall trend is still in place even as Stevens takes little comfort it in it given its slow pace. The Australian dollar topped in 2011, and the sell-off from 2013 has produced lower lows and lower highs - trademarks of a continued downtrend.
Be careful out there!
Additional disclosure: In forex, I am net short the Australian dollar