FedSpeak Lost In Translation
Given recent commentary from the major central banks most important to us it is surprising that the Australian dollar has cracked the US80c mark over the past week. Market just don’t seem to be listening – or don’t believe - what central bankers are saying.
Let’s start in the United States. The Federal Reserve’s decision to leave interest rates on hold this past week was widely anticipated, as was the Fed’s subtle hint that it will likely announce the commencement of its run down government bonds at the September meeting. Indeed, the Fed indicated “the Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated.” It also pledged to keep gradually raising interest rates – noting “the Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate.”
Yet for some reason, markets took the statement dovishly, and pushed down bond yields and the US dollar. It was the catalyst for the $A’s advance. To my mind, the Fed is still on course to starting running down its huge war chest of government bonds by September, which should over time help unwind the unusually low level of US government bond yields. Barring a major economic shock, the Fed is also on track to lift rates again in December – even if inflation remains broadly around just current levels just under the Fed’s 2% target.
But here’s the oddity: while markets continue to take a dovish view of whatever the Fed says, they are more resolute in expecting hawkish central banks elsewhere.
Indeed, over the past month or so there seems to have developed a theory around markets that many of the world’s central bankers had conspired to ramp up their tightening rhetoric. That stemmed from the fact the European Central Bank started talking about a possible scaling back of bond buying next year, the Bank of Canada actually lifted rates (albeit from a very low 0.5% to 0.75%).
Yet recently, we’ve had Australia’s two most senior central bankers (Deputy Governor Guy Debelle and Governor Phillip Lowe) comprehensively pour cold water over the idea that it might announce a surprise rate hike sometime soon. And central bankers in Japan and New Zealand have also refused the follow the market’s expectation.
In a speech this past week, for example, RBA Governor Lowe declared “just as we did not move in lockstep with other central banks when the monetary stimulus was being delivered, we don't need to move in lockstep as some of this stimulus is removed.”
Even in Europe, it’s likely the Draghi will drag out the tightening schedule. Indeed, all he’s really talking about so far is making a possible announcement at some time about when next year the ECB might begin to scale back the billions in bonds it’s still buying each month. The ECB is still way behind the curve compared to the US Federal Reserve.
All this suggests to me that the US dollar has become somewhat oversold – after having been a very crowded long trade at the start of the year. Of course, another major factor undermining the greenback are the antics of the Trump Whitehouse, as prospects for significant tax cuts and higher fiscal spending are looking less bright given the entrenched divisions between the hard right and more moderate republican members of the Senate. God help us, there’s even a risk of another US government shutdown if there’s failure to eventually pass a resolution to lift the debt ceiling constraint.
Meanwhile, continued good US earnings results – together with still low bond yields are a more competitive US dollar – are positive factors for Wall Street. Everyone is waiting for a decent pull back to buy, but the market keeps creeping ahead to new record highs.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.