The Australian Dollar and a Cheap Money Addiction

The Australian Dollar has surged to the highest levels this year on hopes of, you guessed it, ‘stimulus’, (from China, not Australia) and the prospect of higher domestic interest rates in the future (because of said stimulus). As the chart below shows, it’s now nudging up against the 200-day moving average (red line).

Australian Dollar Gaining Strength


click to enlarge

In our view this is a counter-trend rally and will peter out soon enough. In late 2013, the AUD rallied from around 89 to 97 US cents before selling off to new lows. The same thing will likely happen again, although where this current rally ends we have no idea.

Reserve Bank of Australia chief Glenn Stevens will provide some clues this afternoon when he speaks at an investment conference in Hong Kong. After voicing concerns about the ‘stubbornly highAustralian dollar, in recent appearances Stevens has been more at ease with the currency’s strength.

We think this is because of the recent inflation scare, which showed prices rising faster than the RBA had expected. Much of this related to a weaker dollar which pushed up the price of import goods. Stevens and the RBA likely concluded that the dollar had to fall much more slowly to contain inflation, and so he stopped talking it down.

At around the same time the RBA moved away from an ‘easing bias‘ on interest rates, meaning they were happy to leave rates alone for an extended period.

Now, with the benefits of the RBA’s large 2011/12/13 interest rate cuts in full swing, many economists are calling for a new tightening cycle, with some expecting official rates to be 4.25% by the end of 2015.

We reckon this simply won’t happen. The only way it could happen is if China lost the plot completely and doubled down on its credit boom. That would ensure another terms of trade (ToT) boom for Australia and it would force the RBA to hike interest rates to remove the stimulus that flows through from such a boom.

But that’s simply not going to happen.

Right now we’re in the midst of a decline in the terms of trade. It would be very unusual for the RBA to enter a prolonged tightening cycle while the terms of trade were falling (see chart below). In fact, given the mining investment drop-off that Australia faces now and into next year, it would be a stupid thing to do.

click to enlarge

If anything, you’ll see one or two rates hikes before the effects of tighter money bite. The Australian economy is addicted to cheap money. Higher interest rates now would quickly end the economic momentum.

From October 2011 to August 2012, the RBA cut the official cash rate from 4.75% to 2.5% – a historic low. That’s 225 basis points in cuts in just over 18 months. Coming from an already low base, that’s a significant amount of stimulus. In fact, it was too much.

With a lag of around 12 months, that monetary stimulus has been washing through the Australian economy for a while now, which is why all the interest rate sensitive sectors have been going gangbusters. We’ve had another housing boom, which is causing all sorts of social problems.

But it’s not sustainable growth. It’s short term, and once the stimulus wears off those sectors will be begging for more.

So don’t expect interest rates to rise too much, if at all, anytime soon. Glenn Stevens probably realises the RBA cut a little too much in bringing rates to 2.5%, and now he’s OK with a stronger dollar taking a little heat out of the economy. It buys him time.


Greg Canavan+
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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