Australian dollar sucked up RBA group think vortex

From John Durie:

US Fed chair Janet Yellen pleased US stock market investors but delivered Reserve Bank of Australia chief Glenn Stevens a nightmare scenario when she cut expectations for US rate hikes, pushing the Aussie dollar higher against the greenback.

In early morning trade the Australian dollar was at US75.62, up from US68.27 in January, and threatening to halt progress in the Australian economy.

BlueScope’s Paul O’Malley among others have pointed to the lower dollar as being a key reason for the recovery in his company’s outlook, with customer orders increasing on the back of the Aussie’s fall.

Education exports have also boomed with the lower currency.

It is not Janet Yellen at fault here, it is the RBA that is to blame, in failing to foresee and prepare for this scenario even though we’ve already lived through it twice in the past four years.

The AFR is worse:

The employment number was a big miss on expectations given the number of jobs created was 300 vs 13k consensus. Markets rallied anyway because the RBA is very obviously not only not jawboning at all, it is saying things like the above instead, which is a red rag to an Aussie dollar bull.

This is one reason why the RBA is stuck in a disastrous group think feedback loop: there is nobody holding it to account. This is not just a local phenomenon. Central banks carry a halo that inures them to press criticism everywhere. Take Alan Greenspan, for example, “The Maestro” until he crashed into the GFC. Perhaps it’s their nominal independence, their un-elected and unaccountable position, or their constitutions, that protect them. Ours also pulls journos strings with special access and it has a closed mateship culture to boot.

But central banks do make mistakes and ours has made a doozy.

The current overly high Australian dollar is the direct result of RBA misjudgments (as well as some fiscal blunders):

• along with Treasury, it over-egged the mining boom as a “structural adjustment” and thus kept rates and the dollar too high for too long amid an unfolding currency war;
• as such it helped embed the currency as a “go to risk-on” trade for global markets;
• since the mining bust began it held to its beliefs for too long, consistently forecasting high plateaus for commodity prices and keeping the dollar high;
• when it realised the extent of the bust it egged-on a housing price boom that was funded by external borrowing, again supporting the currency;
• as the boom mushroomed, it for years actively argued against macroprudential tools to contain it, again pushing up the dollar;
• it’s jawboning efforts have been shockingly bad throughout and having been through two periods when the dollar refused to fall it did nothing to prepare for a third instead relying on an overly hawkish assessment of Fed tightening;
• it has never argued for fiscal support to lower the dollar which would have put enormous pressure o the government of day for reform;
• finally, it is now in the absurd circumstance of facing a runaway dollar even as it pulls the strings on the Turnbull Government’s resistance to negative gearing reform which would pound the dollar lower.

And so here we are. Various folks will tell you that the Aussie is overvalued or not based upon snapshot-in-time models that are pretty useless. If you look at Australia’s post-mining boom adjustment on a continuum, where it has been and where it is going, the dollar is unquestionably overvalued, probably by as much as 20% now. And that will become clear as commodity prices resume falling and the non-mining export recovery stalls in the second half, ironically leading to more rate cuts and a falling dollar!

So, what needs to be done now instead? It’s very simple:

• the recent macroprudential move on property investors has been a spectacular success, immediately capping house price growth without crashing anything and it will have provided APRA with excellent experience and data on how to measure the impacts of new rules;
• Glenn needs to get on the blower to Wayne and between them announce that they are collaborating on monetary policy to address the global currency war. Believe me, it will make global headlines;
• the duo must announce that they are designing new parameters for macroprudential policy to be expanded in tandem with rate cuts;
• they can do this with or without Treasury. They don’t need any constitutional changes. It can be done through the Council of Financial Regulators.

The Aussie will tank if they do it. Then it will tank again when they implement it. I’m quite sure that they have the expertise to execute without upsetting households. Indeed rate cuts will help boost flagging domestic demand. It needn’t be done all together, either. A rate cut can come first then macroprudential after as needed. And if they’re concerned about running out of bullets for rate cuts later on then don’t be. Only a few cuts will be needed, I suspect, as markets discount the new regime. Macroprudential can be eased with equal fanfare when it needs to be. And the banks will still be able to gobble up net interest margin later if it is needed. Moreover, if you let the dollar run, the outcome is the same only with more economic damage first.

It’s five years too late but it still needs to be done with great urgency.