Will the RBA step in front of the train?

See the latest Australian dollar analysis here:

Macro Afternoon

I’ve raged against the fact that the AUD is hollowing out our import competing industries and our non-mining exports but today, as the AUD careens towards 1.10, I want to focus on whether the RBA is going to do anything about it.
Just now, the dollar is being buoyed by two major themes. The $US is falling and the investment world can’t get enough of Chinese growth. With its rich commodity exposure, Australia is a leveraged bet on China. Throw in high interest rates, low sovereign debt and rocket-like technicals and we have the recipe behind the current tearaway rise.

So against this backdrop there is little the RBA can do to stop the AUD from rising. I’ve always known that, but it doesn’t mean it’s right. I continue to believe that there should be a debate on the impact of the higher Aussie and some concern/help for the industries impacted. Wayne Swan more or less suggested in yesterday’s speech that  we have a bex and lie down. Kevin Rudd appeared on Bloomberg today to, unbelievably, talk the dollar up, saying we don’t intervene. This is a red rag to a bull.

So when will the RBA try to slow the freight train? It’s a hard question to answer but they offer us some clues. First, they specifically state that they favour a “free float”.  That’s code for leave it to the market. But there are some rules of engagement set out.

The RBA’s approach to intervention has evolved over the past two decades. Broadly, there has been a shift away from concern about short-term volatility in the early post-float period to a focus on episodes where the exchange rate has clearly overshot. This change in emphasis has resulted in intervention strategy moving from generally small daily interventions with frequent changes in direction (often described as ‘testing and smoothing’) to less frequent but larger scale intervention once the exchange rate had moved a long way.

So Rule 1: Save your bullets, don’t intervene too often and only when it has moved a long way. Back to the RBA:

Of course, the important issue is to identify in practice when the exchange rate has in fact overshot. Typically, the RBA has come to regard overshooting as unlikely to be occurring unless the exchange rate has moved a long way and, as noted, the move does not appear to be supported by economic and financial factors. This approach effectively means that the bulk of the RBA’s intervention takes place around the cyclical highs and lows in the exchange rate.

Rule 2: Don’t intervene unless it has overshot (either side up or down) and its move isn’t supported by economic and financial factors. “Financial factors” are likely to be investment fundamentals, not just economics. Back to the RBA:

In addition to circumstances where there appears to be misalignment, the RBA will also consider intervening in the market when conditions threaten to become disorderly. Persistent volatility, a sharp widening in bid-ask spreads or erratic movements of the exchange rate (especially at times of uncertainty about macroeconomic policy) may result in intervention to help restore order. Having said this, the RBA has become more comfortable with the ability of the market to cope with shocks of various types, so episodes when intervention is motivated by the desire to avoid disorderly conditions have become much less frequent.

Rule 3: Intervene if the market gets disorderly. This is what’s called smoothing and testing. They don’t draw a line in the sand but just ensure the market functions. I’ve seen them do this many times and they used to have to be particularly active at the end of the trading week in New York, our Saturday morning. I also saw them do this one morning around 10am when the market hits a raft of stops and traders couldn’t clear. The resultant gap got them in and clearing. Back to the RBA:

Neither of the two reasons for intervention discussed above suggests that intervention could be used as an effective instrument of policy for achieving a particular level for the exchange rate. Nor does it imply the use of intervention to correct a monetary policy imbalance or to resist changes in the exchange rate which are in line with broader economic or financial developments.

Rule 4: This is the freight train rule. The market is the market, we don’t draw lines in the sand and we don’t stand in the way of a freight train unless any or all of the above 3 rules are satisfied.
So how does the AUD stack up at the moment?

1. Has it gone a long way? Yes.

2. Has it overshot? The dollar is supported by economic and investment factors and is at the high end or above most fair value models. So we’re getting there. However, Glenn Stevens is on the record describing a $1.10 scenario in which the RBA would not intervene. Having said that, he also described $1.10 as “way up“.

3. Is the market disorderly? It’s rising fast but disorderly generally means “gapping”. Big moves of 0.6 or 0.8 cents. So, no, not yet.

4.  Is it a freight train? Yes and we haven’t satisfied the above rules yet so get out of the way.
So the RBA will not yet intervene. And with producer prices out today showing higher than expected inflation from oil, they may even think this surge has an upside. Though I reckon above $1.10 the finger will quiver on the trigger.

In the mean time, the best we can hope for is that the government doesn’t make it worse by jawboning the dollar higher.  Markets love a dare.

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  1. Arr.. Don’t worry it’al all even-out in time…and,
    Please consider the man that earns 20 grand a week pays the same price for his chops and fuel as does the person that earns 1 grand…JR

  2. I would leave well enough alone.

    It has been proven in the past that when central banks interfere, the result is minimal, as the trend always continues.

      • Deus Forex Machina

        even though i’m a market guy the reality is they still trust markets too much

        • Central banks trust markets? – Seriously?

          C’mon, in this day & age CB (or their country equivalent) are manipulating markets to within an inch of their stochastic life in order to promote whatever economic agenda of the day they have.

          POMO comes to mind here, as does China’s impending purchase of Spain…

          • We ARE talking about the AUD are we not?

            What can the RBA do other than wave a wet towel at a raging bull?

            (Would not surprise me if the largest exposure is held by China.)

            Looking at the FRB they have done a fine job of junking the USD (Yuan with it) yet they can, in other words ‘do not fight the Fed’; they can print all they like to malign the currency to other currencies and try and increase USD manufacturing and bottom tier traders. Impact is felt on commodities, yet deflationary on other assets.

            The Yen carry trade enjoying the ZIRP. Money has to flow somewhere at such cheap prices! So why not here with our high interest rates and ‘stable’ ASX (mind you that is questionable)?

            ECB intent on creating a mirage for Germany, whilst the periphery suffers and other countries … pity Brazil ???

            Every central bank, including the US has a problem with currency manipulation (and the inherent value in a floating exchange), empirical evidence is brilliant precursor to what lays in the future.

            Look at Swiss and their failed attempts during GFC, then look at Japan and their forays to attempt to fix a problem recently.

            History proves that it is a worthless and expensive exercise.

            Singapore the biggest manipulator against a hidden casket, yet their problems surfacing internally, as it is with every manipulated currency.

            Then again .. we could be that stupid … like Costello selling our AU stocks at a realistic price, as we had plenty in the ground!

          • Bah, this commenting system could really use some improving:

            1) allow more nesting (replies-to-replies-to-replies & so on)

            2) lighten-up on the graphics, leave more room for the comments


            Woah, don’t get me wrong, I’m in complete agreement with your ‘do not fight the fed’ position, as well as the futility of currency intervention programs. That’s a losing battle & best avoided. IIRC I expressed a similar view in a prev. article somewhere here.

            I took issue with DFM implying markets were currently running relatively free from interference. That’s just not the case, methinks. FRB, being the most high profile of the bunch, is up to its neck in market manipulation with its QE programs. Further, Bernanke seems to have deftly maneuvered himself into a corner come June/July.

            As for the Yen carry trade, you’re bang-on as to where much of that money goes, although it was a wipeout a month ago. Who’da thunk an earthquake/flood/chernobyl could be bullish for national currency.

            Oz risks becoming stuck with Dutch disease – our economy is fast-becoming a derivative of the value of our dirt & can probably be modeled as such.

            OK – here’s where I get political 🙂 – Russia suffers from the same problem, although they are bending over backwards to stimulate their other manufacturing/technology (ie: export) industries – whether that succeeds or not for them remains to be seen, but I don’t see our gov. pushing any similar projects forward.

  3. While the US keep borrowing money and lack political the courage to raise taxes and trim their deficit, the US dollar will continue to fall. $1.40 doesn’t seem out of the question. Can’t see how the RBA can do anything to control a continued fall in the US dollar. RG

  4. DFM

    I agree with your assessment. But do you think that the RBA has any thoughts on the fact that our debt to the rest of the world in terms of the rest of the world has gone up by between 20 and 30%?

    Have a good easter!

    • Deus Forex Machina

      Hey Deep T…interesting question. Glenn Stevens has been asked this a few times lately when he fronts parliament. They don’t seem overly concerned with the absolute level per se. But how about I come back next week with more detailed thoughts.
      Have a great easter yourself.

    • Foreign debt rising is not too much of a problem, as the value of our asset grows by the same amount as well.

      The Australian dollar became the 2nd worse performing currency in the world after the Japanese earthquake. It is now at $1.07. It’s probably better to just let the market run its course. In the meantime, buying gold with AUD and then selling it later is a really attractive trade..

      • Sshh..don’t tell anyone about that trade Ronin (I’ll be posting about that subject over the Easter break)

        BTW – I think gold is just about to break out of a reverse H and S on the spot market – its at $1507 right now (6:48 EST) Yes I’m trading it…can’t help it.

  5. They should at least be on the phone to Bernank and TimmyG and giving them some QE related abuse.

  6. The SNB very recently tried to intervene and were crushed. We don’t stand a snowballs against the “the market”.

  7. Easter 2011. The week Australia’s non-resource tradeables sector finally cracked.

    There will be a lot of soul searching this weekend. Factories will be closed, projects will be cancelled. No-one can survive this onslaught.

    For those of you in the FIRE industries the AUDUSD is just a number to be gambled with up and down. Sometimes you make money on the long side, sometimes you make money on the short side. The absolute level doesn’t really matter.

    But for us poor mugs exporting real products priced in USD, parity is a catastrophe, $1.10 is a cataclysm. We can’t make our money back next week/month/year when the AUD comes back to Earth. We’re gone. We’ve closed. Employees laid off, never to return.

    • Deus Forex Machina

      Yep…thats what I fear, it’s why we’re trying to make so much noise here at Macrobusiness…best thing for everyone, except the longs, is a swift and sharp reversal.

      • Talking your book again? Why not move to Zimbabwe and talk about devaluation there, see how far you get?

        I’m a producer (cattle & sheep) & see no problem with a ‘strong’ dollar, though it seems impossible to get through to you that the AUD is merely stable at present rather than strong.

        I’m not saying the situation will last, indeed it probably won’t but as I’ve stated here before, devaluation does not lead to prosperity, rather penury.

        • Deus Forex Machina

          Hey JMD…as Neils Bohr used to say “we practically agree”


          this is not Mugabe’s Zimbabwe’s, we don’t have hyperinflation, we don’t have a failed financial system and we don’t have veterans taking peoples farms and livelyhoods.

          We’re not talking Aussie back to .4775, we’re not talking it back to 60 or 70 even we’d just like some time for industry to adjust.

          Some of us who earn Aussie, have debts in Aussie, have assets in Aussie can actually care about those businesses in Smithfield, Newcastle, Cairns and other places that are getting smashed. There is no book to talk.

          Deep in my bones this strength feels like it is hostage to the current market and the point you make about it not lasting I hold also but it is why I think we shouldn’t simply accept the US and China having artificailly low currencies. If you and I are wrong and it does last for 1, 2 or more years the impact is terrible for our econlomy.

          Have a great Easter…Deus

          • I still find the AUD pretty average compared with the Euro and GBP. Would love parity with the Euro, will never happen though!

            Its not that its an overly strong AUD, its Bernanke and his shafting the USD with all the printing. QE.

          • “If you and I are wrong and it does last for 1, 2 or more years the impact is terrible for our economy.”

            I simply can’t agree. If these businesses can not adjust with their terms of trade improving almost daily, than they need to look at what they’re producing.

            We may not be Mugabe’s Zimbabwe but hyperinflation is just devaluation on steroids, who says we don’t have failed financial system? I’d have thought a government backstop was screaming insolvency out loud and lastly the government devaluing the dollars I get paid for my product is theft.

            Oh, the reason why I don’t see the situation lasting is because the AUD is still a credit bubble, despite its current stability. If your fellow bloggers were smart they would be using the current gold price to accumulate it rather than ‘profit’ by rolling over the unpayable debt of the government.

          • Guys, this is more than just a ‘trade’. Its not a game. Real businesses get hurt when the currency moves this quickly.

            While I’m fascinated to read what you guys have to say about the gold ‘trade’, going long this or short this, none of this actually contributes anything of real value. Its all just numbers on a screen that you either guess right or guess wrong.

            The real heroes of the economy are businesses that invest in new products and services and sell them to the world. These are the businesses that are being absolutely smashed at the moment … and when you continually punish your best and brightest they eventually give up, close down, or move on.

          • The AUD vs any currency is very high…Euro, Pound, Kiwi Peso, USD…..the rate has more to do with high interest rates and speculation than high terms of trade…..can anyone remember who was the Prime Minister when we last had a Balance of Payments surplus?

            If it was the terms of trade was really the reason for the high currecy then we would be rolling in foreign income!

            We should drop our interest rates by 1-2%, look at money supply re-regulaltion, short term withholding tax hikes for speculative plays in our currency and money market and other tools to drive down the dollar to the long term averages because in my view the global AUD market is not efficient it is manipulated by hedge funds and other speculators.

            The long term damage to the non-dirt digging economy is serious and needs to be addressed now.

        • JMD:

          Mate, you might be getting better $USD prices for your cattle and sheep every day. I’m not. My $USD prices are flat, so my revenue in $AUD terms is crashing. I think your perspective would be very different if you were in my shoes.

        • Agreed.

          Intervene in the AUD (it won’t work anyway we are talking a $50B short to make an impact) for a short term correction (The DXY broke 75 down and is the driver).

          Then pay $2.00 at the pump.

          Plus add 10% to fruit, veg, JMD’s meat and lamb.

          Destroy the consumer. Good idea.

          • Ditto that Rota. The populace will only stay docile for so long if the true impact of the commodities inflation came to bear. Go forbid if the bogan has to spend $140 filling the V8 ute!

  8. It would be interesting to get people’s views of the impact of ‘events’ and where (all other things being equal) the AUD should/would sit in response. Some examples: housing market correction with no marked China slowdown; housing market correction China hard landing (this one is a bit of a no brainer); end to QE with no other market changes; decent post-quake Japanese recovery; decent US growth data later in the year (without QE prop).

    The problem I have is that, with US and Japan rates ostensibly anchored for the foreseeable future and a flood of capital flowing into Australia, it makes sense to be long AUD even at $1.07. What impact would some hawkish Fed rhetoric later in the year have? Even some closing of the rate differential must be negative AUD at the margin? What chance of a surprise Aussie rate drop in light of housing decline and a crushed consumer? What price AUD then?

    For what it’s worth, I think the market is bonkers at $1.07 but I can see it going parabolic. My short was stopped out long ago, and I’m sitting on the sidelines from here until sense prevails.

    • I was only talking with my wife the other day about this and we were going “what if the AUD keeps going and gets to $1.45 USD”.

      We both thought it was not likely, but we also both feel the market tends to run far further and for longer than you ever think possible. Being short is great when you are right, and one day you will be right, but be early and it will wipe you out.

      Interesting days. Sitting on the side seems a good idea. We have money in USD and AUD so we are watching carefully.

      This gold trade is looking better and better…

  9. Craig
    It depends on whether you are talking about ‘Balance of Payments’ or ‘Current Accout’ Balance of Payments is almost a meaningless number as it only accounts for imports and exports. It doesn’t account for, e.g. interst and dividend payments to foreign entities and a whole host of other payments we make. Balance of payments is a bit like talking the ‘Gross Income’ of a business where fixed costs are not taken into account. Therefore we should talk ‘Profit and Loss”
    In answer to your question then we did have a small Currrent Account Surplus in 1971. Other than that we have to go back to 1959.
    The cumulative Currrent Account Deficits through that 50 years have all been paid for by Foreign Borrowing and, more importantly, the sale of our industries, farms, mines and in-ground resources to foreign interests.
    I fail to see why anyone thinks this has been a good thing.

    • Therefore we should talk ‘Profit and Loss”
      Should read
      Therefore we should talk “Current Account”

  10. will be interesting to see what bernanke chooses, let the market tank or keep the ponzi going then we will see were the AUD goes. If it keeps climbing we can buy the world no?

  11. after reports on china massive inflation and overbuilding it cant be china growth going forward, i see it as pure speculation because of weak USD aka carry trades….this will end badly for the amateurs trading.