The Australian currency is at it again. Today it hit its highest level since June.
Here’s the chart against the USD since the start of August, via investing.com:
The story of the Australian dollar in the last six weeks has become one of defiance. Many thought the Australian dollar was on an assured decline from around April, and would be trading in the US90c range for the year.
In the previous sentence the word “many” is intended to include Australia’s biggest financial institutions.
And the Reserve Bank. And Treasury.
The resurgence of the Aussie dollar against the greenback is great news if you’re thinking about a shopping trip overseas or jumping on to Mr Porter to pick up a belt and a new shirt. (Or planning on doing the Christmas shopping in the Black Friday sales, just six weeks away now.)
Australia’s broader economy, however, has been counting on the value of the currency to fall so that other export sectors beyond resources could become better value to overseas buyers.
The reason the RBA and the newly-installed federal Treasurer, Joe Hockey, will be hating to see this is that the value of the currency feeds into economic projections and, consequently, government planning, particularly as the newly-assembled government works out what it’s able to afford to do.
In an open economy like Australia’s, big moves in the currency can have far-reaching implications for business and government.
Back in May when it looked like the Aussie was set for a continuous slide — some banks were predicting an exchange rate of below US90c by December — someone told me the story of an exporter friend who makes software who had been “waiting for years” for this to happen. They were excited. To their customers, the cost of buying their stuff would fall. The time had finally come when their product would square up against international competitors on price.
If you threw a rope around all the businesses who were similarly excited you’d have a large chunk of the economy looking forward to selling more stuff, taking on more staff and growing their businesses and the economy along with it.
In August, banking research firm East & Partners published some research confirming this. They surveyed more than 850 exporters for their Aussie dollar forecast, and the predictions were under US92c in September and under US89c by December.
As September began this looked correct but then the currency started to rebuild strength.
A few factors drove it. A big scare around Emerging Markets, particularly India and Indonesia, came to an end, bringing some confidence back to the Australian dollar. And it started to look like Australia’s domestic conditions were picking up: for example, retailers got a little perkier, signalling that Australians were ready to open their wallets again. As a result, forecasts for another cut to official interest rates started being pushed from November to next year.
And then the US Federal Reserve, after its September meeting, announced there would be no tapering of its asset-buying program because the US domestic economy wasn’t quite strong enough yet.
The vertical green line where the Aussie spike briefly above US95c before is from that day. (I’ll come back to this.)
Other things have happened since that have helped prop up the currency. There’s been a reasonable feed of decent domestic economic data. Barack Obama’s nomination of Janet Yellen to replace Ben Bernanke as Fed chair helps too, because the market expects her to keep the QE program going for as long as it takes.
There are a stack of other factors – uncertainty around the US debt ceiling this week being one of them – but when you put them all together, here we are, heading into the end of October with the Australian dollar having recovered about half of the ground that it lost since the slide began.
This is a bit brutal but you can roughly equate this to wiping out half of the certainty that business, government, and banks had about the currency’s direction six months ago.
The RBA does of course have some shots in the locker in terms of further cuts to interest rates. But here’s the thing: the single biggest mover of the Australian currency last month was a decision by US officials (the Fed statement); and the end of the sell-off in Indonesia and India also helped the rebound.
These are entirely beyond the control of Australian officials and affect the ability to forecast the economy’s future direction accurately. In business this can affect confidence. But in politics, particularly after Hockey made so much noise about the forecasting accuracy of Treasury officials – now his Treasury officials – it can affect the perception of competence.
There are footnotes in two separate documents, one from RBA and another from Treasury, that may need some urgent revisiting if the Australian dollar doesn’t return to where it was in a bit of a hurry. (And if it does head back towards US90c we can return to being in awe of the forecasting wizards.)
In the RBA’s Statement on Monetary Policy from September, their projections from the domestic economy are based on two technical assumptions: the Australian dollar being at US90c, and the Trade-Weighted Index (a measure of the currency’s strength against key trading partner) at 69.
Treasury’s Pre-Election and Fiscal Outlook, released for the federal election campaign, made its forecasts based on the dollar being around US91c and the TWI at 70.
As of today, the Aussie dollar is comfortably above US95c and the TWI is at 72.6. A resolution of the US debt ceiling wrangling in Washington by the weekend has the potential to unwind a lot of Aussie dollar’s recent gains (although one trader has suggested the price action lately suggests it could get a further bump).
But still, if in August you’d predicted those numbers for mid-October, people would look at you as if you had a second head.
In the aftermath of the shellacking it copped over its forecasting record midway through the year, the PEFO tellingly contained some charts from Treasury that showed the ranges that economic outcomes can move when you shift various dials.
There’s a reason for the common saying in the Australian financial markets that the country is a “cork in the ocean”. You can see it in the impact the QE surprise had on the currency last month. A major shift up or down in China’s projected economic activity could play havoc with projections for Australia’s domestic economy. And this includes levels of tax receipts and therefore the budget outcome.
With Australia’s huge trade exposure, and at a time of continuing uncertainty about the global recovery, this is a conversation that we should be having all the time.
Prime Minister Tony Abbott said he wanted to deliver “adult government”. A good place to start would be being a bit straighter with voters about the limited level of control government and our national institutions have over key economic levers.