On today’s menu we’ve got a bit of humble pie served with a side of I-told-you-so.
(I would have named it after a politician with something terribly witty to boot, but what pollie ever admitted they were wrong? Not Mal Brough.)
Why am I standing before you, cap in hand, head hung in shame?
The Aussie dollar.
If you’ve been following these posts for a while, you might remember that almost exactly two months ago, I was predicting that the Aussie would stay stuck above parity. (You can read the full article here).
Back then, the Aussie was trading at 105.46 U.S. cents, and gently holding there, like a yacht off one of Richard Branson’s islands.
This week it’s touched a low of 93.27 U.S. cents, and could well have further to fall.
So there you have it. An 11.5 percent fall in two months. Pretty sharp. And pretty wrong on my part.
So back at the Olympic village, as we pour over the video replay of the game, what lessons can we learn? What went wrong?
Well to start, I might, your Honour, offer a few words in defence.
First, the sudden nose dive of the Aussie has taken everyone by surprise. The broad flow of market predictions back in March was for the Aussie to hold around where it was, or keep moving higher. I remember a certain economist with one of the big 4 saying that he was expecting it to push though 1.20 sometime this year!
But it’s a cheap defence to stand next to a bigger fool to make yourself look less foolish.
But the other thing I might note, your honour, is in that particular article, I reported that on pretty much every measure available, including RBA research, the Aussie was over-valued. HSBC said the AUD/USD was the most over-valued currency in the world.
So I was expecting it to come back to ground at some point. Just not so quickly.
So getting back to the post-game analysis, why was I thinking that the Aussie would remain above the cloud line?
There were two key factors. One was the attractiveness of Australian government debt. You’ll remember I said that Aussie government debt was our second biggest export in 2012.
Australia had been lumped with the poison chalice of being regarded as a ‘safe-haven’. And with the Aussie dollar enjoying safe-haven status, high demand was locked in, particularly as the rest of the world continued to muddle along.
The other factor that seemed central to me at the time was that Australia was likely to keep itself out of any currency wars that might erupt. While Australia runs one of the cleanest floats in the world, foreign powers seemed to be lining up to throw their weight on top of their currencies, which would have kept the Aussie afloat.
All good in theory. So what happened then?
Was there a sudden re-evaluation of the Australian outlook that made foreign investors nervous about stashing their money here? No.
Did Glenn Stevens decide he was going to get all Dirty Harry on the Aussie? Nup! (As much as I’d love to see Stevens do a Clintwood impression. Imagine that!)
Or was there a sudden collapse in Australian LNG projects, that meant that foreign companies no longer needed Aussie dollars to fund their investments? Nope. Nothing like it.
So what was it then!?! C’mon Hitchcock. The suspense is killing us.
It was the US recovery…
… in the kitchen with a sledge hammer.
Yep, the bounce and boing in the recovery has taken everyone by surprise. Yes. Even me.
If you’ve been reading these blogs, you’ll also know I’ve been pretty up-beat on the medium term prospects for the US. But even I was caught off-guard.
The US economy is picking up speed. We saw a strong pick-up in house prices – with the housing market showing the most enduring strength in years. And perhaps most importantly, the laggard labour market is finally making some headway – generating jobs and calling people back into the labour force.
Then to top it all off… Ben “I’m smart ’cause, I wrote an essay on the great depression” Bernanke when asked about the continuation of money printing on the back of positive news… stalled with his answer, looked side-ways and took 5 sec before saying “we will still keep a close eye on it…” or word to that effect.
Boom the little Aussie was history…Down ya go my little friend.
And so what’s going on with the AUD/USD has nothing to do with the AU, and everything to do with the US.
The resurgent US outlook is causing people to reconsider the US’s traditional safe-haven status, and is calling scared chickens home to roost. And perhaps most importantly, the Fed is making noises about starting to think of maybe beginning a dialogue that could eventually initiate a process that could begin to unwind quantitative easing.
Careful! Even whispers of it can send markets crazy.
There were a lot of folks who shorted the USD, effectively betting that quantitative easing would eventually destroy the currency. Theoretically, that is what you expect to happen at some point.
However, it now seems that there’s a chance that the Fed might right the US boat before any of that happens. So I reckon a fair bit of recent strength is short-betters covering their arses.
So there you have it. At the end of the day, it’s a good news story. The US is bounding back, which is great for the global outlook. And a resurgent US is beating down the Aussie dollar, which is great for domestic producers.
But hang on! What about interest rates? The high AUD was one of the things keeping the foot to the floor as far as rate cuts were concerned. Does this mean we’ll see rates rise?
Well, we’re a long way from that. What I think will actually happen is that Dirty Glenn will let the fall in the dollar be eaten up by the current rate cutting cycle. There used to be a rule of thumb that a 10 percent devaluation in the Aussie was worth a 25bps rate cut.
So we might miss out on one extra rate cut this year. Which, I don’t think so.
But the fact remains the RBA still has a strong easing bias, and Glenn will be happy to keep some of his powder dry.
And look, ultimately, it’s still an exciting result for property investors and good news for the outlook.
Which is exactly what I’ve been saying all along!
(Sorry. That’s as humble as this little pie gets).