The Fed’s decision not to reduce the amount of bond purchases at this month’s meeting is ostensibly about the US economy.
But the interconnectedness of markets means the Fed’s decision has implications for every other nation’s central bank and monetary policy.
Now of course the Fed hasn’t changed the monetary policy that the Reserve Bank sets here in Australia, or across the Tasman in New Zealand or indeed for the ECB in Europe. But the monetary conditions in an economy are more than just the level of central bank interest rates. The monetary conditions in an economy are a combination of a number of things but ostensibly the primary two drivers are,
- central Bank interest rates; and
- the level of the exchange rate – in Australia’s case the Aussie dollar
That’s why the RBA in its Statement from Governor Stevens after the Board Meeting this month, and for many months prior has said:
The Australian dollar has depreciated by around 15 per cent since early April, although it remains at a high level. It is possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy.
The RBA is saying that the Aussie dollar has a role to play and that it needs to head lower to help spread the economic recovery more evenly through the economy and “rebalance” growth.
But the Fed is making this readjustment by the Aussie dollar problematic for the RBA by weakening the US dollar and in so doing driving the Aussie to the highest level in 3 months. With the Aussie sitting at 0.9516 as I write it is now only off 9.88% since early April.
The chart above shows the relationship between the moves in the Aussie Dollar and the RBA’s Australian Trade Weighted Index. The relationship is apparent and while the AUD rate has been altered to reflect the overnight move the TWI won’t be adjusted till later this morning.
But the key here is that Australia has just undergone a tightening of monetary conditions – RBA rates are still at 2.5% but the Australian Dollar is up more than 6 cents from the lows and risen also on a trade weighted basis which is more important for the economy.
The RBA won’t like the decision by the Fed not to Taper – it means that the adjustment to the Aussie dollar has been delayed and with the chances of further gains or at least a reduced possibility of big falls for a while the chances of another RBA cut have just increased materially.
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