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Last Monday – talked about exchange rate basics

Summary – There are a number of factors that go into analysis of the fundamental health of economies and the implications for currency movements – and in turn these can affect the exchange rates –

  1. Went through indicators that show the flows and trends of supply and demand – like the balance of payments (capital and current accounts) and the level of foreign reserves a country has – including economic indicators like inflation, interest rates, GPD – all go towards affecting the exchange rate movements –
  2. but these are only at a cross currency level when looking at say the AUD to USD
  3. Today – Look at some of the reasons behind movements of AUD to USD
    1. Major things to look at:
    2. Central bank policy – interest rates, inflation expectations – influence trading behaviours
    3. Trading positions – what professionals are betting on
    4. The trade markets – current account and capital accounts – historical data
  4. No way to accurately predict the movements minute to minute – reading tea leaves – so what do the leaves say

Starting with central bank policy – The AUD/USD exchange rate has been retracing some of its decline –  

  1. However – a small Reversal of this trend started following the Federal Open Market Committee (FOMC) Minutes being published –
    1. The Federal Open Market Committee- group within the Federal Reserve System responsible for overseeing the nation’s open market operations – makes key decisions about interest rates and the growth of the United States money supply
  2. Shows the power of central bankers over currency – even based around their statements (not actions) currency exchange rates can move –
    1. AUD/USD pulled back from a fresh 2020 high of 0.7276 – this was due to that in the FOMC Minutes – the Fed foreshadowed a change in the monetary policy outlook- said they would employ an outcome-based approach versus a calendar-based forward guidance 
      1. Under ‘calendar-based guidance’, the central bank makes an explicit commitment not to increase interest rates until a certain point in time.
      2. Under ‘state-based guidance’ or outcome-based approach the central bank says that it will not increase interest rates until specific economic conditions are met.
  • Feds reasoning – “a number of participants noted that providing greater clarity regarding the likely path of the target range for the federal funds rate would be appropriate at some point.” – but not at this stage
  1. Forward guidance is what markets respond to here – what central banks are pointing at for the decisions
  1. So the current market conditions may keep the exchange rate afloat as the crowding behaviour in the US Dollar looks poised to persist over the remainder of the month
  2. However, it seems as though the FOMC is in no rush to alter the course for monetary policy
    1. the committee vows to “increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace,”
    2. Chairman Jerome Powell said that they will stick to the status quo at the next interest rate decision on September 16 as the central bank extends its lending facilities through the end of the year
  3. Back with Australia – At the same time, the Reserve Bank of Australia (RBA) Minutes suggest Governor Philip Lowe  will also retain the current policy at the next meeting on September 1 as “the downturn in the first half of the year had been smaller than predicted,” and the central bank may carry out a wait-and-see approach throughout the remainder of the year – so they have a outcome/state based approach as well
  4. The RBA is waiting for the likely effects now that the government’s fiscal stimulus programs like the Jobkeeper Payment have been extended for a further six-months.
  1. Looking at the interest rates – the RBA may continue to rule out a negative interest rate policy (NIRP) for Australia as “members agreed that the Bank’s policy package was continuing to work broadly as expected,” 
    1. the limited scope for additional monetary stimulus may provide a backstop for AUD/USD as the FOMC shows little intentions of scaling back its non-standard measures in 2020.
    2. As a result, the Australian Dollar may continue to outperform its US counterpart as AUD/USD approaches the 2019 high (0.7295) – now the currency is above this – gone to 0.7366
    3. and current market conditions may keep the exchange rate afloat as the crowding behaviour in the Greenback looks poised to persist for a little while yet –
      1. Everyone was jumping into safe investments – either USD or USD backed securities like treasuries – look at this late with the capital account
    4. RBA Governor Phillipe Lowe stated that “The Australian economy is going through a very difficult period and is experiencing the biggest contraction since the 1930’s. As difficult as this is, the downturn is not as severe as earlier expected and a recovery is now underway in most of Australia”. 
    5. When looking at the Aus interest rates – At the last RBA rate decision on August 4, officials chose to hold the overnight cash rate at 0.25 percent
      1. Also – maintained that same yield target for 3-year bonds – a few weeks ago, officials said they are prepared to adjust the stimulus package if the circumstances warranted it
      2. So policymakers believe that additional fiscal and monetary support may be necessary for some time
    6. However – if economic improvement continues better than expected – the need to introduce additional stimulus will reduce
      1. This may then push AUD higher if investors focus on swift recovery expectations
      2. But many things could upheave this – such as heightened geopolitical tensions between Australia and China – which could cap the currency’s gains
    7. The other thing that is being looked at – Economic Stabilization efforts
      1. As the statement by RBA Governor Phillipe Lowe states: “The outlook remains highly uncertain. The recovery is expected to be only gradual”.
        1. However – if the Governments re-imposes more aggressive lockdown measures – may create additional negative sentiment – affect things like current account
        2. This being said – may be offset may renewed risk appetite and signs of global stabilization.
      2. For a country like Australia – that has a cycle-sensitive currency based around trade and that is tied to an outward-facing or export economy – early signs of improvement in global trade is re-assuring
        1. The data to watch here are trading reports– such as PMI reports (Purchasing Managers’ Index – shows prevailing direction of economic trends in the manufacturing and service sectors) – so if this is increasing and is coming out of developed and emerging markets – reinforces the notion of improvement, the Australian Dollar may rise
        2. However – if it is lower than anticipated or starts to decline – then the AUD may decline
      3. Major thing about economic stabilization – effect on currency movements will be to the magnitude of aggressive support by central banks
        1. But this come from flow on effect – such as how this affects business confidence and risk appetite – if this goes up – adds another upwards pressure on the AUD.
        2. Looking at Deutsche Bank’s Australian Dollar currency index compared to an AUD inflation swap zero coupon (10Y) shows price growth expectations rising in tandem
  • Shows at the moment there is an underlying expectation that future economic activity will rise, and with it, price growth in the form of inflation – not hugely – back to around 2%
  1. So a change of tone in the RBA’s sense of urgency may magnify AUD’s gains – particularly if economic data domestically and in China – Australia’s largest trading partner – shows a brighter outlook and geopolitical tensions simmer down

Traders – what is happening in currency markets between AUD/USD

  1. Sentiment reports – shows retail traders have been net-short AUD/USD since April –
    1. latest update showing 44.00% of traders are net-long the pair – which went up slightly – as there was a small decline in the net-short positions
    2. The recent rise in net-long position comes as AUD/USD bounces back from the previous low – while the decline in net-short interest could be indicative of stop-loss orders being triggered as the exchange rate trades to a fresh yearly highs – now at 0.7366
  2. However – Overall – 26% of traders are bullish whilst 74% are bearish – but these traders are short termed focused – looking at the day/week price more so than a longer term trend
  3. Looking at the technical data – but the Relative Strength Index (RSI) – indicates if an asset is overbought or oversold – showing currency is slightly in the overbought territory.
    1. Keep in mind, the advance from the 2020 low (0.5506) gathered pace as AUD/USD broke out of the April range, with the exchange rate clearing the January high (0.7016) in June as the Relative Strength Index (RSI) pushed into overbought territory.
    2. AUD/USD managed to clear the June high (0.7064) during the previous month even though the RSI failed to retain the upward trend from earlier this year, with the oscillator pushing into overbought territory for the fourth time in late-July.
    3. The RSI started to indicate that there was an establishment of a bullish trend in July as AUD/USD traded to fresh yearly highs, but the indicator continues to deviate with price as it snaps trendline support after failing to push into overbought territory.

The trade markets – current account and capital accounts – historical data

  1. Balance of payments
    1. Current account – was positive for Aus – large exports being around $8.5bn worth next minus imports
      1. US – no shocker is still a mass importer – negative $50bn – so this is in Aus favour
    2. Capital Account – capital flows – negative $11.5bn for AUS – so some capital flight has been occurring
      1. AUs not going on holidays – more money being spent here – less overseas – may be a factor for exchange rates
    3. US saw a massive capital inflight in March – was close to $350bn in a month – since then has been on the decline as well
  2. Foreign reserves – AUD has declined – since March gone down from $90bn to $60bn
    1. USA – has risen – Went from $128bn in March to just under $140bn last month
  3. But still the major contributing factor seems to be the central banking policies at this stage


So in summary – Expect the currency to be volatile –

  1. Likely to go through periods of movements upwards above over time – but will have reversals along the way
  2. Central banks are playing a wait and see game – But this can be in Australia’s favour – with the Federal Reserve doing absolutely nothing to save the US dollar anytime soon, the AUD rising relative may be a trend that should continue to have legs going forward for the near future – obviously – if the US all of a sudden wish to raise their currency on the floating markets – they have deeper pockets –
  3. Alternatively – if conditions change – which they will – currency could go anywhere

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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