Hey, don’t worry I’m not suffering a mild case of schizophrenia here… although it was important to get your attention.
You know my views… I wrote about them last week.
But not every one agrees with me, so I thought we should consider their argument.
…and then I want to add more weight to the my point of view, which I think you will find really valuable.
Here we go…
A few pundits are saying that we could be staring down the barrel of interest rate increases sometime this year – that the next move in interest rates could be up.
HSBC chief economist Paul Bloxham (ever heard this guy talk? Refined tone, very intelligent, super smart and convincing) has gone out on a limb and is telling anyone who’ll listen that this easing cycle is over.
He’s still a lone voice in that noisy boredom (the collective noun) of economists, but there’s a certain logic to his argument.
Rates are at record lows and at what is obviously a very stimulatory level.
Unemployment is steady at a pretty low level (any nation in Europe would be over the moon with 5.4 percent!) Growth seems to be returning to trend as the big international issues that threatened the outlook late last year seem to have sorted themselves out.
America is up and going again (the Dow is at an all time high as I write this), China is back on track and Europe is more funny, but also more stable.
In the old days, it’s exactly this change to the outlook that would drive a reversal of rates from levels like these.
But that was the old days.
Bloxham hasn’t realised that the game has changed. Radically. Put away your bat and get out your footy boots.
There is one factor that dominates all these other factors, and is putting massive downward pressure on interest rates:
The Aussie Dollar.
The Aussie dollar wobbled a little this week, and looked for a second like it might break back down through parity, but is currently holding around 102.5 US cents.
Ah parity. It still feels like a dream. I remember when an Aussie dollar barely bought you half a US dollar, let alone more than a full one. Isn’t it wonderful?
Well, yes, if you’re holiday anywhere outside the Eurozone, but if you’re an Aussie manufacturer, trying to sell things on the global stage, then it’s a total disaster.
And not only is the Aussie dollar super high, it’s higher than most people reckon it should be. It’s anyone’s guess as to what the “fundamental” value of the Aussie is, but right now it has a reputation for being one of the most over-valued currencies in the world.
And right now this is creating a major headache for the government and the boffins at the RBA. We need the get the party out of the kitchen, so to speak.
We need the heat coming out of the resources sector to be lighting fires under domestic manufacturing and consumption.
But a high Aussie dollar is throwing water on all that…
And so business groups across the country are calling on the RBA to do what they can to bring the Aussie back down to Earth.
Does the RBA have the power to do this? Yes.
If the RBA lowered rates, it would make Australian assets, including government debt, less attractive to foreigners. Less capital inflows means less demand for Aussie dollars, which in turn means a lower exchange rate.
Do they have the will to do this?
If they did, they would have already have done this and the rates would have been at 3% (cash rate) 12months ago.
The RBA runs what is known as a “clean float”.
That is, they just step back and let market forces determine the price of the Aussie, possibly stepping in to steady any sudden or drastic movements.
A lot of other countries, like Japan, run “dirty floats”. That is, they let markets determine day-to-day movements, but they have a clear view on the range they’d like the currency to trade it – even if they don’t admit it publicly.
And essentially they’re trying to keep their currencies cheap, to give their domestic industries a helping hand. Australian businesses often wish the RBA had such a generosity of spirit.
The trouble is that if every country is trying to keep their currency cheap, you end up in a currency war – a vicious spiral of devaluation.
And so there’s been an uneasy global truce over the past twenty years. Trouble is, when you’re economy’s stuck in the shoals of the GFC, the currency lever become pretty tempting.
But so far, the RBA has held it’s ground and is letting the dollar do its thing.
But the RBA isn’t blind to the effect the high Aussie is having on the economy. And so while they might not be lowering rates to make the Aussie cheaper, the high Aussie is keeping a lid on things.
Here’s the RBA’s Glenn “let the good times roll” Stevens, with his usual poetic flair…
“… as we have noted repeatedly, the exchange rate remains somewhat higher than one might have expected given the decline in export prices so far observed. This has been a relevant factor in the setting of interest rates. It is not that interest rates are seeking a particular exchange rate response, but they are being set with a recognition of the exchange rate’s effect on the economy.”
So what’s the short of it?
As long as the Aussie stays elevated, rates are staying down.
And so while we might see some strength coming back to the Australian economy, the RBA will be waiting for the impact of the high Aussie to wane before launching back into raising rates.
But the funny thing is that as the Australian economy continues to improve, and as long as we’re still ahead of the rest of the world, and as long as there’s still pretty and valuable things to dig up out of the ground, global funds are going to keep flowing our way.
This will mean we might actually be well into the recovery before the RBA even starts thinking about raising rates again.
But by that stage, a booming recovery and record low interest rates will already have had a massive impact on asset markets, particularly property.
So while the high Aussie might be bad for some, it’s good news for investors.
This is the new game in town.
Signed with Success,
P.S. Look out for part 2 of this story tommorrow… there was so much more that I wanted to tell you but had to run off and take care of a few other things.