Australia steps up the currency-war rhetoric; inadvertently puts floor in FX market

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Australia has stepped up its assault on a perceived overvaluation of its currency, but might well have inadvertently set up a soft floor in its currency.

Glenn Stevens, governor of the Reserve Bank of Australia (RBA), said in an interview with The Australian Financial Review that with falling terms of trade he expected the Australian dollar to be lower than its current rate and that $0.85 was “closer to the mark” for AUDUSD.

AUDUSD dropped over a big figure on the news, from above $0.9050 to stand just above $0.8900.

Putting a number on a desired level for AUDUSD is a new departure for the RBA, which only recently declared that currency intervention was part of its monetary policy toolbox.

Indeed, Stevens voiced a preference for the currency to take the strain in any bid to boost activity in the Australian economy.

“To the extent that we get some more easing in financial conditions, at this point it’s probably more preferable for that to be via a lower currency at the margin than lower interest rate,” he said.

RBA triggers Aussie dollar sell-off
 
Source: XE.com

Maurice Pomery, chief executive at FX consultancy Strategic Alpha, says the comments “stick two fingers up” at the G20, whose members have pledged to avoid using their currencies as a policy tool.

He wonders whether it might ratchet up the so-called currency wars, especially in Europe, perhaps triggering a response from Mario Draghi, president of the European Central Bank, as EURUSD flirts with two-year highs around $1.40.

Glenn Stevens, Reserve Bank of Australia chairman
“My point is, why then does Draghi stick to the rules and not come out and suggest EURUSD should be at $1.10?” asks Pomery.

He says the action by the RBA is the next step to what might be full physical intervention if the Australian dollar doesn’t sustain some weakness.

“So being short [ Australian dollars] with the central bank behind you and the real-money accounts not yet having a chance to adjust to this probably makes sense,” says Pomery.

“AUDUSD remains a sell on rallies and possibly anything above $0.90 as reserve manager account will be hoping for a rally for sure.”

Others are less concerned over any action from the RBA, however.

Gregg Gibbs, strategist at RBS, says that Stevens, by mentioning the $0.85 level and that the current level of AUDUSD with an 8-handle is in the central bank’s “ball park” of fair value, will be hard pressed to repeat the line from a week ago in the RBA’s rates decision press release that the currency is “uncomfortably high”.

At the time, AUDUSD was trading above $0.91, and the comments helped pushed the currency down towards $0.90.

Gibbs believes it is actually surprising that Stevens did not try to leave the impression with his latest comments that he would like to see the Australian dollar even lower.

The bottom line, says Gibbs, is that he now estimates that the risk of intervention by the RBA below $0.90 in AUDUSD is zero and only rises above 50% if the currency rises above $0.95.

“By mentioning $0.85, the governor has actually helped set a floor that the market may well buy ahead of; shorts are probably already trimming positions,” he says.

“Stevens does not really provide much incentive to sell [AUDUSD] below $0.90. Anything with an 8-handle is in the ‘ball park’, unless of course there were to be a significant further fall in commodity prices.”

That does not mean that the fundamentals have changed for the Australian dollar, however.

As Gibbs notes, it is well known that the country’s resources investment cycle has peaked and this is likely to have negative consequences for the Australian economy over the next few years. Indeed, that basic underlying fundamental has helped change the nature of the Australian dollar from a bull to a bear market this year.

“Investors want to be short and don't need much encouragement,” says Gibbs.

“So regardless of Stevens’ view of where the ball-park fair-value is at this time, ultimately Australian dollar price action is bearish and the broad underlying fundamentals challenging.”

In other words, while the Australian dollar is likely to continue on a downward path, the latest comments from the RBA probably means that price action in AUDUSD might get a bit sticky around $0.85.