by Joanne Masters

There is an almost universal expectation that the A$ should be weakening, with many forecasters looking for the local unit to slip below 0.90 against the US$. A lower A$ seems likely given a modest global outlook, moderating commodity prices and a strengthening US$.

Despite this backdrop, in the last month the A$ briefly pushed above 0.95, before settling in a tight 0.9350-0.9450 range. And just as the A$ hasn’t weakened as expected, neither has the US$ strengthened as expected (partly reflecting the reluctance of US bond yields to rise). 

While this may be annoying for economists and traders, it has been frustrating for policymakers; who have been hoping for a weaker A$ to offset some of the fiscal tightening put in place by the Federal Budget and to provide some support to the export industry as it adjusts to a less robust commodity market. Indeed, in early July, RBA Governor Stevens commented that the A$ is over-valued “and not just by a few cents” and the minutes from the July RBA Board meeting noted that the A$ is up 8% on a trade-weighted basis this year despite lower prices for bulk commodities. 

So, why isn’t the A$ following the script and weakening? 

At present, there is a strong consensus about the broad fundamentals. Commodity prices are moderating. The domestic economy is adjusting to a less robust commodity market but humming along much as anticipated. The US economy is recovering broadly as expected and the Fed continues to taper its quantitative easing program.

All of this is priced in to financial markets, and there has been little new direction to provide price impetus to currencies. 

The stickiness present in the A$ is largely a reflection of timing – both the reality that several key factors pointing to a weaker A$ are unlikely to come to fruition in the near term (or even this year), and the associated uncertainty with forecasting something 12-18 months in the future. 

This is particularly the case with interest rate differentials – a key component in forecasting the A$. 

First, monetary policy settings in Australia are expected to remain on hold well until late 2015 / early 2016. 

Second, while the Fed is expected to wind down its asset purchase program by the end of this year, a move to raise the Fed funds rate is unlikely before mid to late 2015. [This weeks FOMC does not include any forecast updates or associated press briefings, and is widely expected to reaffirm prevailing views]. 

This expectation of a prolonged period of policy stability leaves currency markets with little fresh information to trade on. In addition, financial markets are in the midst of the traditionally quiet period marked by summer in the Northern Hemisphere. 

So what could get currency markets firing? Financial markets are forward looking; they will try to anticipate, to look for any shift in rhetoric from policymakers. 

In particular, financial markets will be looking for signs that the US Fed is gearing up to raise rates. This would confirm that the economic recovery is firmly in place and will highlight that the US economy is in a better place than its European or Japanese counterparts.

The difficulty is that the US Fed is very conscious of the still tentative nature of the US economic recovery, and conscious of not rocking the boat with early rhetoric about tighter monetary policy. Fed Chairman Yellen remains cautious in her commentary about the economic recovery and monetary policy. Indeed, in her recent testimony, Yellen said “Although the economy continues to improve, the recovery is not yet complete” and reiterated that current interest rate settings would be “appropriate for a considerable period after the asset purchase program ends”. 

This cautious approach is not surprising given what is at stake. Indeed, as RBA Governor Glen Stevens noted last week,  “My view is that policies were effective in averting a potential catastrophe five years ago. But fostering a strong recovery has been much more difficult”. 

So, we wait for the Fed to end its quantitative easing program and then we watch and wait for the recovery to become more sure-footed, for Fed officials to start to hint at a uniformly more confident and balanced economic outlook, to hint that rate hikes could be coming. 

In the meantime, the A$ treads water. It can’t rally too much because the fundamentals don’t support it, but it can’t weaken too much because the US$ is not ready to fill the space. 

Prolonged periods of range trading are not unusual for the A$. And so we wait. Those brave enough will trade the range, those with medium term objectives will be looking at rallies as opportunities to establish short positions. 

The remainder of 2014 is unlikely to hold much excitement for the A$, unless something unforeseen significantly changes the likely timing of US interest rate hikes. 

 

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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