There was lots of hand-wringing last week when the RBA decided to leave rates on hold at the record modern low of 2.25%. Some commentators postulated that this would ignite an Aussie dollar rally because the RBA needs to cut rates to get the Aussie down.
But what they fail to grasp is that the dollar’s value stretches beyond the ambit of Martin Place to an almost endless list of factors, including interest rate differentials, commodity prices, Chinese growth and gold, however one of the primary drivers of the AUD/USD exchange rate is the USD side.
That’s important because, for example, when you buy BHP shares, that’s exactly what you get, whereas every currency bet is relative: the Aussie versus the US dollar, the Aussie versus the Kiwi, the Euro versus the Yen and so on.
That means it’s hardly ever just about one side of the cross. At different times it’s one or the other, a combination or some other continuum along that vector of influence.
What the RBA has been doing since Glenn Stevens made his first verbal intervention back in 2013 is pointing out that the AUD is overvalued based on the fall in commodity prices. More recently, as the Fed signalled an end to QE and now, increasingly, the commencement of the tightening cycle, the RBA’s speakers have highlighted the strength in the US dollar will naturally force the Aussie dollar lower as the Fed tightens.
Governor Stevens summed up these twin themes nicely in his statement after the decision to keep rates on hold last week:
The Australian dollar has declined noticeably against a rising US dollar over the past year, though less so against a basket of currencies. Further depreciation seems likely, particularly given the significant declines in key commodity prices.
So, no doubt he’ll be pleased with these two charts from Westpac and Morgan Stanley, which show both the importance of the US dollar to the AUD-USD moves and that the US dollar is still expected to be gaining strength in 2015-16.
The Westpac chart shows USD moves dominate the Aussie dollar TWI (trade weighted index) moves. As the USD TWI falls, the Aussie TWI rises and as the USD TWI has been rising from its lows – around the time the AUD-USD was hitting the highs of 1.10/1.11 – the Aussie has been falling.
The $A has been quite stable of late… despite RBA ‘jawboning’… and a further collapse in iron ore. The currency continues to trade…at a premium…to its fundamental fair value. We view this situation…as a temporary state of affairs. We see the $A at 72¢ by December, Westpac Chief Economist Bill Evans said in a note to clients Friday.
So in this context of the US dollar driving the AUD-USD rate, Morgan Stanley reckons that while the US dollar’s 7% per quarter rate of growth is going to slow to 2% per quarter in the year ahead they remain “structural dollar bulls”.
The RBA has been managing a fairly clean float for the past 32 years. Their ability to let the Aussie dollar move through a 63 cent range (0.4775 to 1.1080) since the float in December 1983 as it tightens or loosens effective monetary conditions in the economy has been, and remains, a masterclass of central banking.
Just as they have for 32 years they prefer to nudge the market to its “own” conclusions rather than intervene.
If Westpac and Morgan Stanley are right, it seems that, once again, they will get the outcome they want.