BMO Capital Markets sees increasing links between A$ and ‘currency wars
The recent move by the Reserve Bank of Australia to cut interest rates and provide support to the economy is inextricably linked to the global ‘currency wars’, argues a note from BMO Capital Markets.
Whilst the RBA’s challenges are far from enviable, market participants (ourselves included) have the interesting challenge of having to re-teach themselves the “ins and outs” of Australian fundamentals – primarily because the AUD has been viewed as a “strong buy” for so long whilst global capital flows have essentially made these fundamentals rather unimportant. This is another way of saying that the “strong AUD” theme has essentially become embedded in the psychology of market participants all across the globe.
On balance, we think it’s essentially up to the RBA to try and tamper with or fundamentally alter this psychology if it aims to keep the AUD below its 2011-2012 averages (roughly 1.0350 versus the USD and 75.00 on a trade-weighted basis respectively). Whilst we aren’t promoting a reliance on nominal exchange rate valuations as a means of securing sustainable, long-run growth (just look at the shape some EMU countries are in today as a result of relying on persistent devaluations), we also think there is enough evidence (both “hard” and anecdotal) to suggest that 1) the AUD is no longer able to act as a cyclical buffer to weakness in the non-resource sectors of the economy and 2) the rapid revaluation of the AUD over the last half-decade or more has essentially outpaced the competitiveness of the non-resource sectors of the economy.
Effectively, this latter piece of evidence is like being a runner and having a 10-foot hurdle placed in front of you – whilst you are running. The exchange rate should always naturally work for the benefit of the domestic economy, not to its detriment. If it fails to do so, we would argue that the central bank may have a “moral duty” to intervene. We can pinpoint a number key themes which have, secularly, worked in favour of the AUD and, more importantly, intensified within the last few years. These themes are, collectively, at least partially to blame for the general uptrend in the AUD and intra-day or intra-week price action which has displayed a relentless bid during short-run cyclical downturns in the currency:
1)Demand for safe, super AAA-rated EUR alternatives
2)A general rise in nominal incomes and wages, partially reflected in the value of the AUD
3)Strong Chinese demand for industrial metals
4)Favourable interest rate differentials vis-à-vis G7 economies
5)Trading of the AUD as a liquid, free-floating proxy to the RMB.