Glenn Stevens better start warming up his vocal chords

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Earlier this week the RBA, as has been the case since August, noted in its December monetary policy statement “that the Australian dollar is adjusting to the significant declines in key commodity prices.”

The acknowledgement, coming as a surprise to many in financial markets, came despite a significant drop in commodity prices over the past two markets, particularly for iron ore, Australia’s chief commodities export.

According to Ray Attrill, global co-head of FX strategy at the NAB, it has become increasingly challenging to justify the RBA’s statement given the sharp divergence between the currency and commodity prices seen since the end of the September quarter.

Since the start of October Australia’s terms of trade have fallen by more than 6%, a completely different performance to the Australian dollar – known as a commodity currency – which increased 5% in nominal terms over the same period.

Attrill believes that significant valuation gap has opened due to the divergent performance between the two, suggesting that the Aussie may now be overvalued by as much as 8%.

While the RBA have been reluctant to “jawbone” the currency recently, something Attrill puts down to “setting the hares running with regards to the prospect of a resumption of RBA easing when the Board reconvenes in February”, he believes the RBA will have little choice but to reinitiate verbal intervention should the Aussie continue to buck weakness in Australia’s key commodity prices.

“Even if the terms of trades soon stabilises, a failure of the AUD to fall back could well prompt the RBA to restart jawboning against what it sees as fundamentally unjustified strength,” says Attrill.

“If anything close to the current valuation gap still exists come 2016, the RBA may be prompted to recommence verbal intervention.”

With the ECB set to loosen monetary policy further and whispers about the Bank of Japan following suit in the months ahead, the Australian dollar is once again looking attracting on a pure yield basis. Even if the US Federal Reserve raises interest rates later in the month, that’s no guarantee that the Australian dollar will fall given it’s largely built into market pricing.

In a world where interest rate differentials mean so much to movements in currency markets, you can see why the Aussie, despite obvious fundamental reasons for it to weaken further, remains in high demand.

Better start warming up those vocal chords, Mr Stevens. It looks like some jawboning, at the very least, will be required in the months ahead.

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