Forex debate highlights uncertainty

Recent weeks have seen the Australian dollar start to track down against most major currencies, with the consensus position from most forecasters being that the other forecasters are wrong! The normally herd like nature of the exchange rate forecasting fraternity appears to have been whittled away by uncertainty, leaving most to examine the shavings for any real sense of the future direction.

At a basic ‘forecast’ level, there are some expectations that the Australian dollar will relatively quickly slide below USD0.70, mainly due to the differential between interest rates in Australia and elsewhere in the world.

But not so according to some bank economists. The NAB foreign exchange team for instance says the Aussie is under-valued because of fundamentals like commodity prices and risk appetites. They back the Aussie to hit USD0.82 by year’s end.

The NAB was in the majority just one month ago, as William McInnes wrote in the Australian Financial Review:

“…forecasters had been convinced the Australian dollar would challenge US80c at the start of the third quarter, but now currency strategists say it is more likely to push towards US70c.”

Put more simply, they were wrong both in terms of magnitude and in terms of absolute direction. One month ago.


Now, for the sin of hubris that is all forecasting, in this instance we can be a little more forgiving because who knew half the country would be in lockdown? Well, no one, but we all knew it was possible right?

Lockdowns place spending under pressure, draining economic growth and price stimulus impetus that can feed into decisions on raising interest rates. So, the lockdowns point to there being no prospect of short-term action on the official RBA interest rate.

Given the US has wound back its quantitative easing (‘QE’ is the release of money via Bond purchases of the Central Bank backed up by their cash reserves) program, its natural interest rates have risen compared to those in Australia. So, the result is cash flows towards the US dollar and away from the Aussie dollar (net-net anyway). That contributes to a lower exchange rate.

Some economists argue the Aussie may also be downgraded in the eyes of currency holders and traders because of the trade and political tensions between China and Australia, but from what we can read, that’s the Ouija board at work, more than something based on boring old evidence.

What really places the Aussie under pressure though is the differential between the US 10 Year bond rate and the Australian equivalent, and that is directly impacted by the relative size of each countries’ QE program.

As Joseph Capurso from the Commonwealth Bank described it:

“For every 15 basis point fall in the spread, when the spread is already negative, the Australian dollar falls by US2c on average.”

Right now, the spread is about negative 8 basis points, which means more RBA purchases of bonds will stimulate the economy two ways: 1. By addition of the cash going into the lending banks from the RBA and 2. Placing general downwards pressure on interest rates (because the cost of borrowing by banks has been reduced).

The RBA was very late to the QE party – only really starting in November 2020. It does not seem to be intent on winding its weekly purchases back at this time. This is what the currency forecasters call ‘tapering’. The RBA would commence tapering its QE program if it considered there was too much money in the economy (inflation was getting out of control), if private sector investment was going off or some similar organic economic event was shoving the economy forward.

That aint happening right now, so perhaps the QE program will continue a while longer, putting downwards pressure on interest rates and ultimately on the Aussie dollar.

Of course, if they do taper the QE program, the Aussie would immediately rise. ANZ bank thought that was not likely in the near term due to the lockdowns.

Alex Joiner at IFM Investors suggests that the RBA could well be the last central bank to raise interest rates. That means the RBA could continue buying up 10 Year bonds for some time to come.

Why would it do that? To stimulate the economy in the face of insufficient inflation and economic growth, and a concern to see the economy right itself with as near to full employment as possible.

To taper QE or not, is the question for the RBA. Essentially, the currency forecasters, no matter how much they have to back up their views, are punting on that one event each month and the implementation of it each week, as much as anything else.

As the great twentieth century economist JK Galbraith opined, “We have two classes of forecasters: those who don’t know… and those who don’t know, they don’t know.”

Jokes about economists aside, there is a great deal of data available right now, and a lot of it is actually contradictory, or at least, potentially so. One thing is certain, the Australian dollar has as many external drivers as internal, so the reflections on the local conditions could all end up being mere sophistry anyway. And that’s an economic opinion you can … whittle away to nothing if you choose.