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Macro Afternoon

News in The Australian this morning that the Russians are buying Aussie Dollars is just another example of the kinds of forces that are at work as a result of the rerating of Australia and our currency. From The Australian:

The Russian Central Bank will pour up to $US5 billion ($4.7bn) into the Australian dollar in a fresh wave of support for the currency, in a move to diversify its reserves and shift away from the US dollar.

The first deputy chairman of the Russian central bank, Alexei Ulyukayev, said that starting from September, the bank would hold Australian dollars for up to 1 per cent of its $US528bn in reserves.

 There are a few points to make about this situation.

  • This is a trend we have been seeing for some time now with more and more central banks buy Aussie. Indeed the RBA minutes from the May meeting made the following comment:

The Australian dollar had appreciated to a fresh post-float high against the US dollar. On a trade-weighted basis, the currency was at its highest level since 1985 and had appreciated by 6 per cent since the start of the year. While this partly reflected the general depreciation of the US dollar, the Australian dollar had tended to rise more than most other currencies. An important influence had been purchases by other central banks seeking to invest their official reserve assets.

  • This Russian purchase is not a very large amount in the grand scheme of things. Global FX turnover in the BIS triennial Survey in 2010 was $4 trillion per day with spot trades representing $1.5 trillion per day of trade.
  • The AUD trades around $304 billion per day globally and about $80 billion in Australia alone.
  • This purchase will be spread out over days, week’s or months and because of the size of the market should not disrupt normal flow for any great period of time.

So while this amount isn’t that large in terms of the overall trade the story and the flow of money into Australia and buying Australian bonds is disrupting our economy because we have seen and are seeing a rerating of Australia and by extension the currency which will keep the Aussie on a higher plain than would have previously been the case. In the Australian article a former colleague, and one market economist worth listening to, Rob Henderson says

“Australia is one of the world’s true AAA-rated government debts at the moment,” he said.

“There is a lot of fear in the world about the situation in Greece and Portugal and Spain and Ireland. And the US has been given a warning by the ratings agencies that their debt could be reviewed.

“The Australian government is seen as an increasingly strong sovereign. (Fund managers) love the Australian government bond market because it is low risk.”

This is the point we make about re-rating. We have:

  • low debt and fairly solid fiscal position
  • a relatively strong economy
  • are tied and tapped into Asia
  • have a strong central bank with a solid track record
  • stable government (notwithstanding this parliament’s issues) and
  • the currency is liquid – so ease of entry and exit

So the question is why are the Russians telling us what they are going to do and why is it only 1% of reserves? The answer to the first question is that they recognise that $5 billion isn’t that great a number and on the second perhaps it’s our share of the global economy which keeps them reticent.  But my guess is that over time they’ll buy more Aussie as will more fundies and other central banks.

Now it is important to understand what this does to the structure of the market longer term.

Once these really long term guys have bought they are fairly passive but they don’t just sit for ever. They tend to trade their positions around a little. So if the Aussie gets to extremes they might sell some or buy some but they are generally in for the long haul so they won’t be spooked out of positions by an equity crash and so on.

Equally the fact that they are buying Aussie and selling out of USD or EUR assets means that the performance of Aussie against these crosses should through time be better than it has been. This implies a higher cross rate and thus Australian business, as noted by Governor Stevens last week, will just have to get used to a higher Aussie exchange rate.

This article in the Australian is indicative of the re-rating of Australia by offshore investors. Schumpeter is being let lose on our economy because of this high dollar and while we know the RBA can’t do anything about it I still believe that the Government should help out industry in the same way we do farmers during a drought.  

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  1. Your sentiments in the last sentence really get to the point here. Do we buffer our domestic firms from foreign economic upheaval, or are we ‘all in’ in this global economy game?

    I think a reasonable middle ground is to support a mining resource tax and a sovereign wealth fund to balance our economy.

    Whether this would have much of an impact on the AUD I don’t know.

    But another part of me thinks – stuff it. Go all in. AUD to $1.25+. The non-mining sectors of the economy will get the shake up they really need to improve efficiency and competitiveness in the long term.

    But of course, there are real peoples lives to consider as well, and shake-ups like that are painful.

    The other argument to consider is that Australian businesses benefit when foregin markets are booming, so why not let them face the risks when foreign markets are failing?

    Given the high probability that any government intervention will be an ineffective mess anyway, maybe we should just let the market do its thing for a while.

    Just thinking about it makes me even less certain of what might be an appropriate government response – if any.

    • I don’t know if there is an appropriate government response and I think the RBA would rather just get on with it.

      Think that if not waiting for quarterly CPI data, RBA would raise in July. They have given plenty of warning, time enough for homeowners to act and business consider appropriate contingencies/restructure for the strong AUD environment.

      RBA has clearly fully briefed government on what it perceives as relatively short-term adjustment difficulties in some sectors and on the necessity of the mining boom (revenues). Julia and co appear to have been drilled on the message. Soft sectors of the economy will have to ‘toughen-up’ (become resilient) and battle on.

      In historical terms we have relatively low unemployment, low interest rates – room to manoeuvre hence to argue that any increase in either measure is simply a return to (or slight increase in) averages.

      (I caught a Bloomberg panel discussion a couple of days ago – consensus – move to commodity currencies, AUD being most recommended – of course, this could just be an illustration of what Avid Chartist says below!)

      • Forgot to add – of course the mining tax has been negotiated (how effective it proives remains to be seen…) and there’s no hope of a SWF. Not part of this government’s lexicon.

        • There’s SFA the government or RBA can do about it. Plan A is go all in for the mining boom. There is no plan B.

          FWIW, I believe there’s a more than 50% chance we are simply leveraging into a ginormous bubble that will leave Australia an economic wasteland when it bursts.

          I would simply ask the RBA restrain themselves a tad when cheering this thing higher. Greenspan was made to look a right nong after with all his ‘new economy’ nonsense when Nasdaq crashed and burned in 2000. It will be far worse for Stevens if Chanos is even half right about China. He’d probably have to leave the country. The Greek riots would be tame in comparison to a post China crash Australia.

          • “low debt and fairly solid fiscal position”

            On paper Australia has this. Those guarantees go south then that wouldnt be the case. Also the banks are being watched by S & P, Fitchs and some others. My feeling alot of these countries RBA’s will eventually get burned on the Aussie dollar. As I said before the USD is only be driven low to counter China screwing with there currency.

  2. Another worthless central banker talking. Who is this guy anyway? He says A, he means B or C or B+C/D.

  3. We should be thinking of how we can vulture the distressed assets of offshore entities using our stronger doller.

    • Deus Forex Machina

      ohhhh yeah…

      If only we had a decent SWF next year or two will offer somoe decent bargains…

  4. The contrarian in me thinks that increased Central Bank buying likely means the top for the Aussie is in or close.
    Why? Such decisions are made my slow moving committees, and can only made when broad consensus is reached.
    Broad consensus is another way of saying “extreme in sentiment”.
    Markets lurch back and forth between extremes in sentiment, so I’d expect sentiment toward the Aussie to decline for a period, in parrallel with a decline in its value.

    • Deus Forex Machina

      i agree avid…feels a little like bell ringing time.

      That was kind of what I was hoping to portray in the piece insofar as they are long term buyers and holders which is a structural support but the FX market is so big this amount isn’t that large and doesn’t change the game on its own.

      • But please note that in pure central banker style he said: “the bank would hold Australian dollars for up to 1 per cent of its $US528bn in reserves.”

        “for up to” = between 0 and $5.2bn

        So you could read the statement in a negative way: not more than $5.2bn

        That could also mean they will be selling if they already hold more than that.

        Anyway, statements “I will buy that” are always suspicious: why would anyone want to announce intentions to buy? Because you want to sell? 🙂


      • Why don’t we just crank up the printing press and pay down foreign debt? If the PTB can find the sweet spot between the two we should be able to restrain the rise in the Aussie dollar while improving the national balance sheet.

        If those AUD end up back in Australia it might be an inflationary impulse but then again there’s no guarrantee that they would circulate. If it did start to impact on the general price level we could offer some tax incentives to lock up the funds in the banking system (for example).

        If the RBA/Treasury was transparent about its intentions to maintain a stable currency then it might be seen as a win-win for investors and the currency issuer.

  5. The other message here is to the US. The Russians are saying they are prepared to hold reserves in currencies other than USD. The AUD debt market is just nowhere near being large, liquid and deep enough for the AUD to become a substitute for the USD, but there is still a message to the Americans: foreign buyers do not want to buy junk and are looking for alternatives.

    • exactly David.

      The Russian would like to remove the USD from its reserve currency position. The statement on AUD is designed as a signal that it is looking to diversify reserves away from USD and towards a wider basket of currencies.

      There is also a question it raises: is the AUD now seen as a low-risk currency, rather than being a commodity-based risk play for bond traders?

      How that plays out will be interesting to watch.

  6. Im cheering a stronger AUD against the EURO…. For purely selfish reasons I have to be honest!

  7. The Russian CB is actively seeking commodity backed currencies. Australia already has a defacto relationship in this area.

    Going out the curve, The AUD should trend higher towards US$2 circa 2015/6.

    Let’s look at some bust dynamics and bang for your buck.

    1927 Bonds crack.
    1929 Stocks crack.
    1931 FX cracks.

    1985 Plaza Accord.-US$ overvalued by 40%.
    1987 Japanese repatriate overseas investments (including US debt held).
    1989 Stock and real estate collapse.
    1994 FX collapse.

    Note that there is a huge time lag between stock market collapse and currency devaluation. This is because the demand for currency goes up (asset sales) as the economy tanks.

    So if and when the bust arrives you can double your bang for your buck on currency translation alone.

    Because you are already holding AUD$ you can pick up commodity assets/shares at very heavy discounts for the longer term.

    Win/win. Double or 4 times your investment. Swap the strong AUD for gold at the Perth mint?

  8. Ive got 25k in US dollars any ideas in what I should do, do you think there might be a rally in the US in the next few months before the wheels fall off or is this the low point for the next few years?

  9. Same here Matt. And some Euro too and I’m seriously torn as to keep them or bail. One hand I think there could be a short term rally in the USD due to the euro blowing up. But long term I can’t see how QE+ can be avoided without serious austerity and there is no appetite for that in the states currently.

    But not sure what a blowup in Europe will do to my euro holdings vs the AUD. Anyone??