New pressures for the almighty Australian dollar

It looks like the long overdue and often remarked upon depreciation of the Australian dollar has started.

It has dropped by around 4 per cent in the last month, not only against the US dollar, but on the trade weighted index which is a basket of global currencies calculated by the Reserve Bank of Australia.

The TWI is the best measure of the Australian dollar as it captures the impact of the changes in value of our dollar against the euro, yen, renmimbi, won, rupee, pound and a bunch of other currencies.

From a level of 80.2 index points on April 12, the TWI fell to 77.1 points at 1600 AEST yesterday and based on the fact that the Australian dollar has slipped a little since that calculation was made, it is likely to be under 77 index points this morning (note the Reserve Bank only calculate the TWI at 1600 AEST each day).

Against the US dollar, the fall has been from a recent peak around 1.0550 to this morning’s level around 1.0165.

There is no doubt the Australian dollar is still overvalued. It looked to be nearer fair value earlier this year as global conditions seemingly improved, commodity prices kicked back higher and the central bank had all but finished its interest rate cutting cycle, or so it seemed. I was certainly upbeat about the prospects for the Aussie thinking 1.10 or even 1.20 in the long run was possible as the global economy recovered.

This optimism has been dashed with global economic conditions taking a turn for the worse, most notably with the cooling of activity in China and the US, but also another leg lower in the European depression. So bad is Europe that disinflation risks becoming deflation, the unemployment rate is above 12 per cent and the European Central Bank is contemplating negative interest rates.

The US is a little better, but there are growing concerns about the sustainability of its recovery. Just last week, the US Federal Reserve left open the possibility of adding to its $US85 billion a month of bond purchases if the downside economic risks it spoke about came to fruition.

These downside pressures in the global economy do not bode well for the Aussie dollar.

Even with the recent small fall, the Australian dollar has not tracked the fall in commodity prices lower. The Reserve Bank of Australia’s own index of commodity prices, in US dollar terms, have fallen 22 per cent in a little over 18 months yet the Australian dollar is only a few per cent below the level it was when the commodity price peak was reached in the middle of 2011.

Had the general correlation between commodity prices and the level of the Australian dollar held, in an approximate terms, it would be trading below 90 US cents now, perhaps well below.

The reasons remain reasonably straight forward for the sustained overvaluation.

In a world still reeling from the fallout of the banking, housing and sovereign debt crisis, investors are placing a premium on low risk assets.

At a conference I was at yesterday with Westpac’s chief economist Bill Evans, he mentioned Australia being a safe-haven for global investors should there be a rerun of the global crisis or even a mild version of it. He also was strongly of the view that the budget next week would pose no threat to Australia’s unsurpassed reputation as a low debt economy. While Bill was of the view the dollar would fall to around 96 US cents in 2014, he also reckoned that even if the government’s net debt doubled (which no one is forecasting by the way), the credit rating agencies would remain positive about Australia’s financial position and maintain the triple-A rating.

With Australia locking in a triple-A credit rating from all three agencies (Moody's, Standard & Poor's and Fitch), our bond and stock markets are a standout for foreign investors. It is increasingly clear that Australia is, for now at least, a safe-haven investment destination in a sea of high level risk.

The status as a reserve currency or even quasi reserve currency sees these investors buy and hold and buy again Australian dollar denominated assets.

Those positives aside, it remains the case that the recent fall in the Australian dollar is the start of things to come. Commodity prices remain soft, global growth fragile and local inflation is very low. The central bank is likely to cut interest rates again in coming months which should, at the margin, take a little support away. Bill Evans might be right to think that 96 US cents is a target for 2014, but history shows that when currencies break out of trading ranges, they tend to move quickly and go further than even the best forecasters expect.

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Anonymous,

The AAA allows superfunds to hold in $A. So if they want to hold cash they must hold the Reserve, the USD, or a AAA rated sovereign. Its mindless, automated trading.

The best way to force the dollar down is renegotiate all the government loans. Especially those state government PPPs. Free up government cash flow. Big private companies are all renegotiating interest paid on their debt. This will hurt foreign banks.

Next let the RBA make a bid in new $A for all of Cyprus's gold. Offer the USD rate in $A. Just making the bid will force the ECB to make a counter bid.

Mint a A$5 coin in silver at 50% real value in silver.

Anonymous,

Geoff,if you check yesterday's posting on the RBA site,you'll find that our Reserve Bank is a big seller of gold...$719,000,000 worth in the last 8 months.
It also looks like they were part of the co-ordinated effort in the April sell-off of gold in mid-April,as the RBA sold $298,000,000 of gold in April alone.Seems a strange thing to do when you're busting to get the AU$ down,because as the AU$ goes down,the value of your gold holdings goes up.I would have waited for our dollar to go down,then make a killing by selling gold.
Most peculiar...perhaps they just do what the US tells them to do...as when they got Gordon Brown to sell 55% of UK gold at $290 per ounce !

Anonymous,

So Geoff,the RBA has $3.77Bn left in gold which is in a long-term bull market,and $41Bn in US$ and
Japanese Yen ,the value of both having the crap kicked out of them with money printing[inflation]...
how smart is that Geoff ?
All I can do is shrug my shoulders and go have a coffee !

Anonymous,

You have to have a very deep bond market to be any sort of 'quasi reserve currency',I hope the Spectator is not suggesting that our three tiers of government are going to borrow a lot more money.
On top of very low interest rates,it looks as though the oldies will have to suffer increases in petrol prices with a lower dollar,and the increases in the cost of everything else because we have to import most things...perhaps that's part of the RBA plan...to rein in imports?

Anonymous,

I'm going to start using this Steven K as a contra-indicator. I remember last time they cut rates there was talking about AUD crashing. Without getting caught up in all the fluff of the article - the biggest enemy to a currency is inflation. Inflationary risks are far greater in an economy printing 85bn a month (and possibly about to increase) vs one which cut by 25 bps.
Evans has been repeatedly wrong on his currency calls. He has been spot on with his interest rate calls though. Perhaps he is able to separate what should happen vs what actually happens.
Abbot needs to get in and cut all this social crap out and stimulate business so that people have jobs in a few years.

Anonymous,

Stephen Your good self ( and the likes of Bill Evans, Mr Stevens, Wayne Swan etc, etc) seem to talk about the high AUD as being something to be proud of and something that's not desirable, all in the one breath.
Not unlike Wayne Swan taking credit for our current record low interest rates ( which to me is surely a reflection of government failure, not success ...yes/no?).
The first step to reforming an alcoholic, is the admission of being one.
The first step to sorting out or exchange rate problems, is to agree that it is a problem.
Until Mr Stevens and the rest of the RBA and our government really come clean on what they REALLY think of our current exchange rate, we might as well just keep drinking.
I think they are privately patting themselves on the back for the current position of our AUD.

Anonymous,

Not sure how this is counted Stephen. Is this the sales from the Perth Mint?

Anonymous,

No,as far as I know the Perth Mint is autonomous,but guaranteed by the WA government.
The gold,US$,Japanese Yen,and IMF SDR's [Special Drawing Rights] are held by the Reserve Bank of Australia for the Commonwealth Government...that is,the taxpayer.

Anonymous,

Then its either a treasury instruction or the RBA is run by morons.

Anonymous,

Well I'm sure China would've been pleased....they bought 200 tons in April alone from outside its borders,and as you know they are the biggest gold producer...so none of their own product leaves the country.

Anonymous,

No doubt when the Chinese are ready to become the printers of the reserve currency they will bid on a euro sovereigns gold. This will have an immediate affect on the value of the euro to zeuro. They can then pick up the best IP at their leisure.

Anonymous,

Yes Geoff,it is thought that China is converting US Treasury Bonds through the BRICS Development Fund at the Shanghai window with the eventual ambition of having a gold standard, based in trade settlement.

Anonymous,

Stephen, I don't think the RBA has been selling gold (too little left!). What the RBA stats probably show is the revaluation in both the gold price and the AUD/USD fx.

Anonymous,

Yes that would be true of the April number Andre.That still leaves $421,000,000 for the previous 6 months when the price was static.

Anonymous,

Just checked the graph for last 6 months Andre...you are right.I apologise.

Anonymous,

Thanks Stephen, you said the magic words. When the dollar breaks out of a trading range, it can fall quickly.

My sentiments exactly, feeding the traders 3%, might not be a great scenario, but if you try to feed them $2.5%, they will "Rip your bloody, arms off".

The RBA has gambled on keeping investment capital (with low reward). We now run the risk of rapid trading, pushing the dollar down. Algorithms, show no mercy. Remember what Soros did to the UK pound.

Well if you dont know, then find out. Believe me, it was not pretty. The RBA can only hope to cushion the blow of a falling dollar, with higher cash rates. Is it too late, has it gone too close to the edge?

Stephen Koukoulas does not know, Bill Evans does not know, I don't know, the RBA does not know. Only the Chicago FOREX traders know.

Anonymous,

Post script: The Chigago Foreign exchange, trades more cash per day, than Australias, (annual) GDP.

Just thought that I should put things in perspective.

Anonymous,

Hi Steve,
There is another local industry that is being hurt by the high dollar, and I haven't seen much coverage about that in opinion; it is the local IT consulting industry.
The high dollar is making it disproportionally attractive for companies to off-shore even higher value-add activities like IT consulting. This trend poses a serious threat to the careers of local experts, pushing some out of the industry. As the dollar declines in value and the trend reverses, local companies are going to find a shortage of local support, with a knock-on effect on consulting rates.
Marcel van Rooyen

Anonymous,

There is a lot of noise about the Euro crisis, forgetting that the crisis is caused by the PIIGS. I for one am looking to invest in my native country, Austria. The Euro is dirt cheap and Austria has an unemployment rate of 4.75%. So when the dollar crashes .......