Is the Australian Dollar getting too Strong for Comfort?

Is the Australian Dollar getting too Strong for Comfort?

4 April 2016, 13:56
Vasilii Apostolidi

The Reserve Bank of Australian meet for their April meeting on Tuesday and analysts at ANZ bank think they may start talking down their currency to prevent further pain to exporters.

For Australian Dollar traders the main event this week will be the meeting of the Reserve Bank of Australia (RBA) on Tuesday April 5.

The RBA is no different to other central banks in that it sets the base interest rate from which the nation’s other bank’s take their cue.

This is important for currencies because when central banks raise interest rates it tends to attract more foreign investors seeking a higher return on their money, and this increased demand translates into a stronger currency.

Currently at 2.0%, the RBA rate is relatively high for the G10 - the Bank of England’s (BOE) base lending rate is only 0.5%, the Fed’s is 0.25%-0.50% and the European Central Bank’s is 0.00%. As such it already tends to attract and be supported by an underlying demand from international investors seeking that rare sweet combination of safety and yield.

Of course having a strong currency is not all it’s cracked up to be, since exporters trying to compete in the global market for their goods are at a disadvantage when their home currency is relatively strong, as this makes them less competitive compared to exporters of the same good valued in a weaker currency.

With supply outstripping demand for global commodities, there is an incentive to gain every advantage over rival country’s exporters, which has led to what some have described as a global ‘currency war’.

The Australian dollar to US Dollar swung lower at the end of 2015 on a combination of rising expectations that the US Federal

Reserve would increase interest rates in 2016, which pushed the USD higher and the RBA lowering interest rates to weaken the AUD and facilitate trade for its struggling exporters, and the resource producers getting hammered by falling commodity prices.

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Since Janet Yellen’s speech to the Economic Club of New York, as well as the recent gains in key commodities such as iron ore, however, the pair rose as the Australian dollar outperformed its US cousin.

Getting Ahead With AUD

This rise from the 0.70s to 0.77s has got some Bank analysts concerned that the Aussie may already be ‘overpriced’.

According to a recent note by Robert Rennie, a strategist at Australian bank Westpac, he heard it from the ‘horse’s mouth’, after asking none other than the head of the RBA, Glen Steven’s, who he met an ASCI event, whether he thought the AUD/USD pair had now entered a ‘higher plane’ in the 0.76/77s.

Stevens answered broadly that he thought the Aussie may have got “a bit ahead of itself”, the rest of Steven’s quote is below:

“Unless you think that the commodity price trend now is different and we are heading back to a world of considerably higher prices for an extended period, and you think the Fed is never going to lift rates, it is not clear that that situation will warrant a much higher exchange rate than this and there is some risk actually that the currency might be getting a bit ahead of itself”

ANZ bank echo the thrust of these sentiments in a recent note when they say they think the RBA will probably voice concerns about the high level of the AUD at their rate meeting on Tuesday. They do however dismiss the idea the bank may try to do something about the stronger Aussie by lowering rates again:

“The RBA board meeting tomorrow will be the main focus this week. We (and the market) are expecting rates to remain on hold at 2% as global and domestic economic conditions have recently been tracking reasonably well. However, we will be particularly interested in any change to the Bank’s comments around the AUD.”

They therefore expect the RBA to tweak commentary around the level of the AUD exchange rate:

“In the previous Board Meeting minutes, there was scant commentary around the currency other than to note that the non-mining sectors had been supported by the depreciation of the exchange rate over the past couple of years. However, the currency was trading around USD71.5 at the time of the previous meeting, but is now hovering around USD76. We therefore think that a tweak to the commentary on the AUD in this week’s post-meeting statement is possible.”

ANZ’s Kirk Zammit and David Carrington expect the central bank to be concerned at the current exchange rate and for their ‘goldilocks rate’ (not too high not too low, just right) in the mid 0.60s:

“We expect that the Bank would not be comfortable with this level of the exchange rate and would much prefer to see the AUD closer to the mid-60s. However, we do not see the RBA cutting rates in a mechanical response to the stronger AUD.”

Nevertheless, they do not see the RBA being prompted into cutting rates unless the high exchange rate starts to have a perceived material negative impact on business conditions, which remain quite robust.

Indeed, domestic macro-economic data has been quite positive in general, notwithstanding this morning’s Retail Sales miss (0.0% versus 0.4% exp).

Unemployment fell in February to 5.8% from 6.0% in the previous month, and inflation is within the 2-3% RBA target range, albeit at the lower end. The housing market is robust and GDP beat estimates in Q4 (although ANZ point out that falling household spending could start to slow GDP). Nevertheless all said the Australian Economy is reasonable shape.

A such overall, ANZ see a rate cut off the cards for the whole of 2016 now, but a cautionary word on the strengthening currency may be the preferred policy tool of choice to keep a cap on the rising Aussie, which could moderate after the RBA release.

A note from TD Securities, however, offers an alternative view, which indicates the possibility that the Aussie could even strengthen following the RBA meeting, as the global outlook has not changed sufficiently for a reassessment, and outside forces remain a significant driver:

“We expect the Bank to again highlight its reluctance to cut, where RBA Edey well summed up current thinking, stating last week that there was little to go on to trigger a reassessment of the global outlook. Those looking for a shift towards a more dovish stance or outright AUD jawboning will be disappointed, hence AUD and bond yields could be higher after the event.”

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