Too Much of a Good Thing in Australia?

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It is indeed an old adage that while goods things are to be preferred over bad things it is possible to get too much of the former. Looking at recent comments from the governor of the Reserve Bank of Australia it is not difficult to imagine how these, albeit old and worn, pearls of wisdom may well have inspired Mr. Stevens in his effort to tiptoe the thigthrope between signalling the intention to raise rates into an expected economic recovery on the one side and trying to prevent the Aussie shoot of on helium into the sun with wings of wax on the other.

(quote Bloomberg)

Australia’s central bank Governor Glenn Stevens signaled a surge in the nation’s currency to near parity with the U.S. dollar has given him scope to slow the pace of future interest-rate increases.

Stevens, who yesterday became the first central banker in the world to raise borrowing costs twice in 2009, said the 28 percent gain in the currency this year may hurt exports and cool inflation, allowing him to “gradually” raise borrowing costs. Just last month, he warned it may be “imprudent” to keep rates at “emergency levels.” The local currency and bond yields fell as traders slashed bets on another quarter-point boost next month, after Stevens raised the overnight cash rate target to 3.5 percent from 3.25 percent. Investors have been driving the Australian dollar toward parity with the greenback, betting China’s economic growth will boost exports from Australia, the biggest shipper of iron ore used in making steel.

Policy makers “are probably glad for the parity talk as it reduces the amount of work they need to do with monetary policy,” said Matthew Johnson, an interest-rate strategist at UBS AG in Sydney. “A December move is a 50-50 proposition.” Traders are betting there is a 50 percent chance Stevens will increase the key rate by another quarter point on Dec. 1, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange at 12:22 p.m. today. Prior to Stevens’s comments, they had a 96 percent bet on such a gain.

Mr. Stevens' comments follows in the heels of the recent push by part of the Aussie towards parity with the US dollar reflected primarily in the fact that the RBA has already raised twice in 2009 (from 3.00 to 3.5%) as well as a growing risk sentiment which is a fundamental prerequistie, in the current market, for observing investors react to (growing) yield differences. In so many words, this is all about carry trade and more specifically about the fact that in a world where the G3 and others are still fiddling with quasi- or outright QE it takes a brave sould to initiate a hiking process since it will mean an immediate reaction in the currency market. This is especially the case when the liquidity anchor effectively constitutes the US and thus; while the US pump priming keeps a floor under risky assets and volatility at low levels it becomes a veritable turkey shoot to gun for those currencies whose central banks are on the hike (see more here).

Following Mr. Stevens' comments, the Aussie did lose a bit of its steam even if many currency punters still see it racing towards parity over the course of the coming year.

For example David Forrester who is currency economist at Barclays Capital expects the Aussie to test the parity level in 2010, a call based on the idea that the RBA will have hiked rates to a full 5.5% by the end of next year. Needless to say, in a world where risky assets continue to fly and risk aversion is kept in check this will provide a juicy interest rate differential vis-a-vis the G3 and thus the carry trade flows (be they actual carry trades or simply spot market piggy backing) will be plentiful. 

The question is of course; can you blame the RBA for wanting to raise rates?

As it turns out, not really and particularly not in light of global central banks' new found focus on asset prices in setting the policy rate. You know, it was all Greenspan's fault and all that jazz. Still, for those worried about a too rapid V-shaped recovery, Australian house prices seem to offer plenty of things to worry about.

From Q3-08 to Q1-09 the house price index (weighted for the 8 biggest cities) fell a modest 5.6%, a drop which has been decisively paired in Q2/Q3-09 with the index rising a cumulative 8%. This picture is repeated if we look at a general gauge for consumer spending in the form of a sector break down of retail sales.

Consequently, the annual as well as monthly flow of retail trade turnover never really went decisively into negative in the context of the financial crisis which has no doubt contributed to the fact that the RBA never really contemplated a move into ZIRP and QE.

What happens next then?

Well as I noted recently, the burden of rebalancing may be tough to carry for those economies who have central banks brave enough to raise interest rates. Ironically of course and if it is really asset prices you are worried about, the risk is naturally that you just end up sucking in liquidity as you which in itself defeats the purpose of the hiking campaign (see Edward's recent piece on Norway for a Scandinavian perspective on this). Naturally, you can retort to Brazil like capital controls, but in a world where capital flows freely and where the global economies are largely interdependent, this is like trying to stop a freight train with a VW Polo. Also, allow me to finish with a small quibble of mine in relation to the sudden urge by part of central bankers to target asset prices. I mean, this is fine and all and for those who know a little bit about monetary policy this is not something completely new. The problem is merely that targeting asset prices may not only be counterproductive in a world where asymmetric liquidity conditions and carry flows are the norm, by targeting asset prices also entail targeting a price which is considerable more volatile than traditional prices (because I assume that forecasting long term asset prices is not as easy as many believe). In this way, a steady gaze at asset prices may also conflict with central banks' general propensity to favor incremental and gradual moves.

Whether this is the case in Australia, only time will tell. Yet, from the lovely fjords of Oslo, to the beaches of Rio, and on to the Great Barrier Reef policy makers may soon learn that you can indeed get too much of a good thing.

The Burden of Rebalancing

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Nothing good lasts forever, or so at least many would have us believe. I shall neatly leave it aside of whether this is true in a general sense but merely note that it appears that we are moving closer to some form of another of crunch here. And my rationale you ask? Well, let me simply note that it appears, despite the fact one would believe that investors' and punters' should know better, that we are headed right back into the same dead end as we did the last time the Dollar was canooled with the Euro taking center stage. Of course, this is not only a Euro story even if it may appear so and in this sense the current environment once again shows us the very real obstacles which exist in terms of correcting global rebalancing since while everybody seems to agree that this is what we need, nobody wants to hold the old maid represented by a role of importer with a strong currency.

Over at Macro Man, the Dollar's recent plight to reflect lingering risk appetite and low volatility (mmm, the USD as the new carry funder) was given an acronym a long time in the form of DGDF (dollar-goes-down-forever) and I am very symphatetic to MM's ending point in today's installment;

It's entirely possible for this liquidity/positioning/DGDF rally in risky assets to continue through year end; in many ways, it's in everyone's best interest for this to happen. But Macro Man can't shake the feeling that we're all repeating the mistakes of the last cycle (in fast forward, no less!) and that when the reckoning comes, it won't be much fun.

In fact, Macro Man does one better I think since he also points to the very telling issue about Brazil and Turkey fighting tooth and nail to avert an appreciation by, among other things introducing taxes on capital inflows (so far, only Brazil has introduced this measure). I cannot tell you how strongly I feel the sense of deja-vu here since this is exactly what happened the last time the USD began a decline everyone hailed as natural and long overdue but whose counterpart in the form of the inevitable appreciation of other currencies was unduly and harsh. This narrative of course does not make sense and it will be interesting to see this time around where the discourse takes us.

In Europe, policy makers are fast becoming very nervous and although Trichet delivered his well known ECB-speak at the most recent board meeting; the mentioning of a worry of excess currency volatility is indeed, as Macro Man also notes, the closest we will come to the ECB expressing concerns over the flight of the Euro.

It is indeed funny to hear the staunch messages of Eurozone officials only to have them end with the almost laughable notion that the Eurozone is very committed to the US' comittment towards a strong Dollar. I find it hard not to agree with first Macro Man that this latter committment may in fact be a myth and then secondly, and as a result, with Willem Buiter that the ECB will need at some point to get serious about the Euro, even if it will be interesting to see whether the ECB is really ready to act here either operationally or merely through a stronger discourse.

Meanwhile and despite the growing woes in Brazil and Turkey (and India) about shouldering the burden of global rebalancing, one economy that appears to be tackling it rather nicely is Australia where an AUD closely approaching parity with the USD does not seem to deter the RBA (hat tip: Stefan Karlsson).

A local analyst on the ground in the form of Commonwealth Bank’s chief currency strategist Richard Grace even ventured the forcast that the AUD/USD would move beyond parity and on to 1.10. I won't dare confirming or denying this point forecast but merely note that as long as the volatility stays low and that risky assets, by consequence, lingers with an upward drift, it is steady as she goes.

So the real question to answer in this context of global rebalancing is not whether it will be sustainable, but rather which chain will break first. Will it be liquidity driven bounce in risky assets that suddenly runs out of steam or will it be a sudden surge in volatility brought about by an "unforseen" event. In the case of the latter I could mention a couple of sources of such an event, but so far the march goes on and the noose is tightening especially in the context of Europe the statements of policy makers are likely to become increasingly desperate.

In the end, it is not up to the Euro (or the JPY) to bear the burden of rebalancing which must fall on the shoulders of economies such as India, Brazil, Turkey, etc. The key here is that the US does need a weak Dollar to reduce the overall borrowing of the economy, but that this is not possible with one or two economies bearing the brunt of the adjustment process. This has long been a widely circulated fallacy in the sense that many have believed that we could simply twist the tables and move from one importer of last resort to another. This is not possible in the current context and is complicated by the fact that as our OECD economies age, they become increasingly reliant on external demand to spur economic growth.

It may take another round of old maid for global market participants and policy makers to get this and if this is the case, let us hope that Spain, Latvia, Germany, Italy, Japan and the rest of the de-facto export dependent economies won't fold in on themselves.

Risk On? The RBA bites the Bullet

I am not an ardent watcher of the Australian economy so I shall leave it neatly to the side of whether this was expected or, Bloomberg so famously puts it, unexpected.

Australia’s central bank unexpectedly raised its benchmark interest rate from a 49-year low and signaled further increases in coming months amid signs the economy is strengthening. Reserve Bank Governor Glenn Stevens increased the overnight cash rate target to 3.25 percent from 3 percent in Sydney today. Only one of 20 economists surveyed by Bloomberg News forecast today’s move. The rest predicted no change.

The local currency jumped as Australia became the first Group of 20 nation to raise borrowing costs since the start of the global financial crisis more than a year ago. Rising job vacancies, retail sales and house prices, plus surging business and consumer confidence support Stevens’ view that the “basis for such a low interest rate setting has now passed.”

Carry traders will of course feel that warm fuzzy feeling in the stomach by now with the prospect of Australia (and perhaps New Zealand or others) raising rates while the Fed continues to supply the system with free liquidity. The only question is of course whether risk is really on here or whether we are about to get hit by another anvil exactly brought about by a retrenchment of stimulus. I don't know, but this is also beyond the point here. The only question which needs to be answered at this point in time is, how high will it go?

To parity and beyond? (graph courtesey of Reuters, click for better viewing)