Dollar gyrations: a week is a long time in exchange rates

Tony Abbott and Joe Hockey settle in to trappings of power and a former US Treasury secretary causes some ripples in the markets. What’s behind the recent roller coaster ride of the Australian dollar and will its rally be sustainable?…


Powered by article titled “Dollar gyrations: a week is a long time in exchange rates” was written by Greg Jericho, for on Thursday 19th September 2013 01.15 UTC

If Tony Abbott and Joe Hockey were in any doubt that being “in charge” of the Australian economy is often more like riding a bucking horse of which you have little control, this week served to give them a quick reminder.

The general consensus is that the biggest problem for the non-mining sector in Australia is the value of our dollar. Since the float in December 1983, the dollar has averaged US$0.75 cents; in the past three years it has averaged US$1.01.

The simple equation is that the higher the dollar the harder it is for industries which rely on exports. So for the past three years manufacturing and other industries – such as tourism – have been crying out for help and hoping for the dollar to fall.

And then in May, on the back of the budget and reductions in the cash rate by the Reserve Bank, the dollar fell in the space of three months from US$1.05 to US$0.90. And yet, despite a few blips since the start of July, it has remained stubbornly around the US$0.90 mark.

And then this week, while Tony Abbott was getting used to his new digs at the AFP college and while Joe Hockey was reading a few incoming government briefs from his department, the dollar rose more than 1% in a day.

The reason for the jump was news from the US that former Treasury secretary under Bill Clinton, Larry Summers, was withdrawing his name from consideration to be the next chair of the US Federal Reserve once the current chair, Ben Bernanke, steps down in January 2014.

Summers was considered President Obama’s likely pick, so his withdrawal was big news in financial circles.

But why did our dollar rise?

Currently the Federal Reserve is engaged in some pretty extraordinary monetary policy – not just low interest rates (effectively zero) but also ongoing “quantitative easing” (which is a weasel word way of saying they are trying to stimulate the US economy by putting $85bn a month into the economy through buying Treasury bonds). This policy not only keeps interest rates in the US low, it also lowers the value of the American dollar, and as a result increases the value of other currencies – such as our little Aussie battler.

The Federal Reserve is now debating when to start winding back (or “taper”) this stimulus. The quicker it winds it back, the stronger the US dollar will be compared with other currencies.

Larry Summers was known to be a critic of the quantitative easing and so, were he to become chair of the Fed, markets were expecting it to be wound back more quickly than if someone else were in charge.

But with his withdrawal the current vice-chair, Janet Yellen, becomes the presumptive favourite. She is known to be a strong supporter of the current policy, and thus markets quickly changed their views of what would happen in 2014.

And so our dollar rose from US$0.924 to $US0.938 in a few hours, before falling back to US$0.93.

All because of something that didn’t happen in the US.

And then on Tuesday the Reserve Bank of Australia released the minutes of its monthly monetary policy meeting. Not surprisingly, it restated its desire for the value of the Australian dollar to stay low, noting, “Some further decline in the exchange rate would be helpful in achieving such an outcome.”

Now this might signal that the RBA would set monetary policy to achieve this aim, but there is a big “but” involved with our current interest rates – the housing market.

It is hard to avoid reading or hearing about the housing boom – which is at this stage more anticipation than reality. Prices have certainly risen but they were coming off a pretty low trough in 2011-12. At the moment, the boom seems concentrated in Sydney where analysts suggest prices could increase by as much as 20% next year, and to a lesser extent in Perth.

While the RBA is not too concerned yet, noting that “households continued to show prudence in managing their finances”, it did express some concern regarding “self-managed superannuation funds” investing in the housing market. The RBA noted that SMSFs were “one area identified where households could be starting to take some risk with their finances” and the RBA indicated it would “closely monitor” the situation.

And so, notwithstanding the RBA’s desire for a low value of the dollar, our currency rose as traders took the view that this meant interest rates were more likely to rise than fall.

Then last night the US Federal Reserve announced it would continue its quantitative easing a bit longer – and so our dollar went up again to US$0.95.

Thus, in the time between the Coalition winning the election and being sworn into government, the dollar has risen by more than 4%. I hope Mr Abbott and Mr Hockey enjoy the ride. © Guardian News & Media Limited 2010

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