It is not often the biggest bear on a currency is its own central bank, yet the Reserve Bank of Australia has been warning for months that the Aussie dollar will slide to match the falling prices of the country's key commodity exports. The RBA's concerted efforts to talk the dollar down, most recently today (Wednesday), have had little impact with the Aussie embedded in a 92-95 US cent range since climbing from its $0.8660 trough in January.
An important reason the Aussie dollar has stayed strong, despite tumbling commodity prices and Australia's record-low interest rates, is that those rates are still substantially higher than in most developed economies. The RBA wants a weaker currency to boost exports and offset a slowdown in mining investment that has weighed on the economy. With growth seen at a sub-par 2.5 percent by December 2014, and unemployment at a 12-year high of 6.4 percent, the RBA is under pressure again to cut rates from already record lows.
Many traders think the RBA should have already cut rates and predict it will have to do so before year-end. Interbank futures imply a one-in-three chance of a move to 2.25 percent by December from the current 2.5 percent. Lower rates would normally be a potent weapon in bringing down the dollar, but analysts said given that record low rates had so far failed to do so, another 25 basis point cut would probably not make that much difference.
Short of intervening in the market by selling Aussie dollars, which the RBA has all but ruled out, the bank cannot not do much more to weaken the currency. "We haven't been minded to adopt that tool (intervention) in this episode to date. I think that has been the right call so far, because there has been a pretty big wall of money coming in," Stevens said at his semi-annual testimony before a parliamentary committee on Wednesday.
Engendering fear has so far been the RBA's main verbal weapon, with Stevens reiterating that the risk of the Aussie declining "materially" at some point was not fully appreciated by financial markets. Analysts suspect this "material" fall could well happen when a rise in US interest rates looks imminent. Ultra-loose monetary policies in the US and Japan and the prospect of bond-buying stimulus in Europe have driven global bond yields to very low levels, making Australia's stable AAA- rated bonds very attractive to the "wall of money" cited by Stevens. Two-year German government bonds offer negative yields, while Spain, Italy and the US all offer miserly yields of less than half a percent. By contrast, the equivalent Australian bond offers 2.5 percent.
Consequently, foreign investors now hold about two-thirds of outstanding Australian government bonds, up from about 30 percent in the early 2000s, and that "buy and hold" ownership is underpinning the Aussie. "In our view, upside pressure on the AUD will persist while the market considers the prospect of more central bank liquidity injections," said Gareth Aird, an economist at Commonwealth Bank of Australia.
"Various forms of quantitative easing from central banks around the world have kept the AUD higher than the fundamentals suggest is 'fair value'," he said. Higher US rates, in particular, could change that equation as the market saw late last year when the US Federal Reserve said it would scale back its bond-buying program.
That sparked a rush out of emerging markets. The Aussie slid from around 98 US cents to below 87 cents from October to January. Yet the real risk may be that the Aussie remains stubbornly high. According to a Reuters poll of 51 analysts, the median forecast is for the local dollar to be at 89 US cents in 12 months. The Fed is expected to start raising rates around mid-2015, but that is around the same time that the RBA is also thought likely to start raising rates. This should cushion the Aussie against the US dollar, said Sue Trinh, currency strategist at RBC in Hong Kong. "We see it trading pretty much in a 90-95 range right to the end of 2015," she said.
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