In October, the Reserve Bank of Australia (RBA) became the first industrialized Central Bank to raise interest rates. It followed this up with two additional hikes in November and December, bringing its benchmark rate to the current level of 3.75%, by far the highest among major currencies.
This series of rate hikes caught (forex) markets completely off guard, and investors moved quickly to price the changes into securities and exchange rates. The Australian Dollar initially spiked more than 7% following the first rate hike, bringing its total appreciation in 2009 to 32%- enough to earn it the distinction as the second-best performing currency, after the Brazilian Real. Beginning in November, however, concerns began to build that perhaps traders had gotten ahead of themselves, and the AUD has been in freefall since then.
Investors now fear that the RBA may have acted too hastily in hiking rates so soon and so fast. By its own admission, the RBA raised rates only after much deliberation: “The rate adjustment ‘would not be intended to slow demand compared with the current forecast path, but aimed simply at keeping the stance of policy appropriate for improving economic conditions,’ ” according to its own minutes. Since the recession was ultimately so mild (some would say ‘non-existent’) in Australia, however, the RBA ultimately decided that (pre-emptive) rate hikes were in order.
Now, interest rates are back in the “normal range,” according to a deputy governor from the RBA. In other words, the current rate is perceived as neither promoting nor hindering aggregate demand, which means it may not need to be tweaked much more in the near-term. In addition, there is growing concern that further rate hikes could trigger a cycle of deleveraging, because of the high debt burdens that plague Australian households and businesses. Household debt already exceeds 100% of GDP, which is even higher than in the US.
Besides, financial institutions are raising their own lending rates by wider margins than the benchmark rate hikes, so there is less impetus for the RBA to act further. Investors appear to have come to terms with this, as futures markets now reflect a 45% probability of another interest rate hike at the next RBA meeting, in February. This is down from 67% only last week.
If you’re wondering whether the RBA could be influenced by the lofty Australian Dollar when conducting monetary policy, it’s conceivable but not probable. It has already acknowledged that the carry trade is generally “back in vogue” and specifically targeting its very own Aussie, but that “As on earlier occasions, the economy has proven to be resilient to these [forex] swings.” If it turns out that the markets truly overestimated the pace of recovery (and by extension, interest rate hikes) in Australia, then the RBA won’t even have to worry about whether the economy can withstand further appreciation, since the AUD would probably remain fixed at current levels.
This series of rate hikes caught (forex) markets completely off guard, and investors moved quickly to price the changes into securities and exchange rates. The Australian Dollar initially spiked more than 7% following the first rate hike, bringing its total appreciation in 2009 to 32%- enough to earn it the distinction as the second-best performing currency, after the Brazilian Real. Beginning in November, however, concerns began to build that perhaps traders had gotten ahead of themselves, and the AUD has been in freefall since then.
Investors now fear that the RBA may have acted too hastily in hiking rates so soon and so fast. By its own admission, the RBA raised rates only after much deliberation: “The rate adjustment ‘would not be intended to slow demand compared with the current forecast path, but aimed simply at keeping the stance of policy appropriate for improving economic conditions,’ ” according to its own minutes. Since the recession was ultimately so mild (some would say ‘non-existent’) in Australia, however, the RBA ultimately decided that (pre-emptive) rate hikes were in order.
Now, interest rates are back in the “normal range,” according to a deputy governor from the RBA. In other words, the current rate is perceived as neither promoting nor hindering aggregate demand, which means it may not need to be tweaked much more in the near-term. In addition, there is growing concern that further rate hikes could trigger a cycle of deleveraging, because of the high debt burdens that plague Australian households and businesses. Household debt already exceeds 100% of GDP, which is even higher than in the US.
Besides, financial institutions are raising their own lending rates by wider margins than the benchmark rate hikes, so there is less impetus for the RBA to act further. Investors appear to have come to terms with this, as futures markets now reflect a 45% probability of another interest rate hike at the next RBA meeting, in February. This is down from 67% only last week.
If you’re wondering whether the RBA could be influenced by the lofty Australian Dollar when conducting monetary policy, it’s conceivable but not probable. It has already acknowledged that the carry trade is generally “back in vogue” and specifically targeting its very own Aussie, but that “As on earlier occasions, the economy has proven to be resilient to these [forex] swings.” If it turns out that the markets truly overestimated the pace of recovery (and by extension, interest rate hikes) in Australia, then the RBA won’t even have to worry about whether the economy can withstand further appreciation, since the AUD would probably remain fixed at current levels.
Kiwi and Aussie Diverge, then Re-Unite
Over the last few months, the New Zealand Dollar and Australian Dollar have largely moved in tandem (see chart below). When the Reserve Bank of Australia raised its benchmark interest rate earlier this month, it shocked the markets and the Aussie shot up, while the Kiwi remained fixed in place. Many observers predicted that such was the beginning of a divergence in the two currencies. Less than one week later, however, the New Zealand Dollar hitched itself back to the Australian Dollar, and the two currencies have since traded in lockstep.
Investors have long tended to view the currencies (and economies) of New Zealand and Australia as one. Both economies boast large export sectors, and for much of the last decade, high interest rates. Given that the carry trade has been (and continues to be) one of the largest forces in forex markets, it makes sense that the Kiwi and Aussie would be grouped together.
Both these superfical similarities mask substantive differences, which have only become more accentuated as a result of the global economic crisis. Alan Bollard, Governor of the Bank of New Zealand summarized this disparity as follows: “Australia has avoided negative growth, and its prospects are driven by strong terms of trade, vast mineral deposits, the Chinese market, and rapid population growth. New Zealand has had a recession, and the pick-up is slower and more vulnerable – a difference financial markets do not appear to appreciate.”
While both economies are currently experiencing negative trade imbalances, New Zealand’s deficit was 5.9% at last count, while Australia’s is closer to 2%. Given that Australia’s (energy and commodity) exports have surged by nearly 30% in the last few months, while New Zealand exports are stagnating, this discrepancy could widen in the coming months. Investment is also surging in Australia, as “The value of advanced resource projects — those that are either committed or under construction — jumped 41% to a record 112.46 billion Australian dollars (US$104.03 billion) in the six months to the end of October.” And of course, the most obvious point of differentiation is between the two economies’ respective benchmark interest rates. Thanks to the aforementioned rate hike, Australian rates stand at 3.5%, exactly 1% higher than comparable New Zealand rates.
It should be clear to most observers that the carry trade is dominating activity in the forex markets. Carry traders, relatively speaking, are undiscriminating, with the main factor of importance being interest rate differentials. Despite the fact that New Zealand interest rates are only 2.5% higher than US rates (and actually less than Australian rates) – hardly enough to compensate investors for volatility risk – the markets are awash in liquidity, and investors are once again chasing yield wherever they can find it.
One analyst offered a frank summary of this phenomenon: “It’s all about the carry trade. The Fed can’t do anything; certainly they can’t raise rates and the market knows that, and is exploiting it for the carry trade, borrowing in U.S. dollars, and the Kiwi is a beneficiary of that…That’s the only game in town. You can forget most economic data, it’s all about…the Fed.” Given that Australian rates are projected to rise faster and higher than New Zealand rates (beginning as soon as December 1), it’s conceivable that the Aussie will outpace the Kiwi. At the same time, the fact that US interest rates will likely remain low for a while means that both currencies will continue to benefit in the short term.
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