One of the striking impacts of the Fed’s unconventional monetary policy since 2009 was the impact that it had on the US dollar which fell into the 70’s against the Yen and above 1.50 against the Euro. The Aussie dollar spent a lot of time above parity as the Fed’s policy shifted the burden from the US to other nations via exchange rate depreciation.
Possibly nowhere else on the globe was the impact of this fall in the US dollar and the associated safe harbour flows that came from an uncertain global environment felt as hard as the Australian dollar and the Australian economy.
The high Aussie dollar meant that the Australian economy got a little bit of Dutch disease.
We relied too heavily on the mining investment boom while our households saw what was happening in other economies around the world and hunkered down, paying down debt, saving more and seeking value in internet purchases and overseas holidays. At the same time our educational and tourism institutions were hit hard by the high Aussie dollar.
Growth was certainly transferred offshore to the benefit of other nations during this period. This meant the previous labour Government had trouble hitting its deficit and nominal growth targets although real growth was helped by reduced inflation.
The deprecation in the Aussie dollar since April and the apparent pick-up in global growth in both developed and, more recently, emerging nations offered Australia an economic backdrop which bought time for a domestic and household adjustment. Volumes and values of exports continued to support the overall economy. Equally a lower Aussie dollar, in the words of the RBA, helped foster a more even rebalancing of the economy and increase the budgetary coffers.
The question now is whether the Fed’s decision to, in the words of the National Australia Bank’s strategy team this morning, “ditch the Taper at the altar”, will see a renewed round of US dollar weakness which will once again see the Aussie Dollar defy the Reserve Bank and remain strong. Combined with the other forces buffeting the Australian economy, what impact will this then will have on Australia, its budget position and the incoming Government’s plans for austerity, Abbott-style?
One of the many challenges Australia’s new Prime Minister and Treasurer face is the convergence of its promises and how economic reality will affect what it can and can’t deliver. Already as Ben Collins reported this morning the Abbott Government is faced with a hard decision over giving more support to Australia’s car industry.
It is an example of the difference between being in Opposition, and governing.
David Scutt from Arab Bank in Sydney told Business Insider today he thought any attempt to try to drag down the dollar would be futile in an environment where the Fed is cutting the US dollar loose. But equally:
The subsequent reduction in interest rates won’t ultimately have much of an impact on the government and the budget bottom line. While they’ll be concerned about the impact of the higher Aussie Dollar on our export-led industries, the subsequent pick up in household wealth from stronger asset prices may well see the domestic economy pick up steam on the back of increased consumption.
So a higher Aussie might actually be good for the economy if it is associated with a better global backdrop and higher stock prices – it’s how it has always worked in the past. A stronger currency meant high growth both here in Australia and abroad.
But the financial crisis turned that on its head and a high Aussie dollar can now be more associated with weaker US and other currencies without the growth benefits that have always accrued to the economy.
CBA Chief Economist Michael Blythe told Business Insider:
Sensitivity analysis by Deloitte Access Economics implies that a sustained one point drop in the TWI would provide a net boost to the Budget bottom line of $1.7bn over four years.
With the Trade Weighted Index – which measures a currency’s power relative to the country’s trading partners – now over 3 points higher than the low on August 7. This is a hit to budget bottom line of more than $5 billion over the next 4 years if this Aussie dollar strength is sustained.
Writing to clients this morning Westpac’s New York based Currency Strategist Richard Franulovich said:
The FOMC has arguably removed the single most bullish prop for the USD today. We see risks that the USD index could test its 2013 lows of 78.92 in coming days and weeks. However, those currencies that were hit hardest by the Fed tapering talk – the dollar bloc and EM currencies naturally stand to gain the most.
Equally the CBA’s Blythe pointed to a note his team published in early August which highlighted the impact that the lower Aussie would have in time if the Taper saw the US dollar strengthen.
A lower AUD will ease the squeeze on some sectors. But the AUD is still high by historical standards. The squeeze from a strong currency has eased rather than disappeared. Greater flexibility does mean that the AUD is now playing its traditional role as an income buffer. The main beneficiaries of this income buffering should be corporate profits and government tax revenues. Households, in contrast, are set for a reduction in spending power as import prices rise. A lower AUD will help boost activity in sectors previously weighed down by a strong currency. But the current mix of favourable inflation drivers could shift in an unfavourable way.
At the moment with the Aussie dollar and the TWI rising the reverse is true. The remaining question is whether the strengths that flow from a higher dollar can be balanced against the challenges it will pose to exporters who have been hanging on tight anticipating a sustained fall in the currency’s value.
The new Abbott Government has hit the ground running, moving department heads and setting to work on their plans for legislation. The Fed’s decision to forestall the Taper, reduce their projections of US growth and undermine the US dollar suggest that Joe Hockey’s promise to over-deliver on the budget and growth is in for a severe test.
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