Currency Market Update: Watch out for the dollar
The Reserve Bank of Australia recently released the minutes for its Board meeting held on 3 May when it decided to maintain interest rates at 4.75 percent for the sixth straight month. The minutes offered some insights into the sentiments of the Board which noted that interest rate hikes were likely to be necessary in the future if inflation remains consistent with its medium term target. This is a clearer indication on rates from the Board than has been the case in recent months. While a rate hike would likely push the AUD higher, a rate rise can still not be seen as being imminent largely because of a number of other factors at play. For example, employment data for April was weaker than analysts expected, with the number of people employed in April falling by 22,100. The number of full-time jobs declined by 49,100 whilst part-time employment rose by 26,900.
Although the weaker than expected employment data initially led to a slight weakening of the AUD, it has since recovered. The currency continues to trade in the region of USD1.05.
The Board’s minutes suggested it will act on interest rates for the interests of the overall economy – indicating a willingness to increase rates if, as is occurring now, some parts of the economy outperform others and push up inflation. The resources sector is a stark illustration of this with overall employment in Queensland and Western Australia increasing by 22,900 – thanks largely to the mining boom. This compares to a decline of 56,200 jobs in New South Wales and Victoria.
Market expectations are for at least one, and possibly two, rate increases before the end of the year. With the currency markets already pricing in one rate rise, further clarity on a second rise would push the AUD higher against most currencies, especially the US dollar. Eyes will be on the next release of inflation and jobs data which will play a significant role in the timing of future rate rises.
The Australian dollar continues to trade in record high territory. This is largely due to the benefits the country is enjoying from the ongoing growth of the vast Chinese economy and its demand for Australian resources. While the official cash rate is a key driver of the strength of the AUD, one of the most significant reasons for the strength of the dollar at the moment is not domestic—it’s the weakness of both the Euro and the US dollar. As such, for Australian businesses, watching the RBA Minutes is probably less important than tracking the relative strength, or weakness of the US dollar and the major European economies. Adding further complexity is the AUD’s popularity with currency speculators. Much of the upward movement in the AUD in recent times has actually been driven by sentiment and the actions of currency traders who are looking to make short terms gains. As the currency’s popularity with speculators has increased, it has become partially decoupled from the fundamentals that typically guide currency movements. Being a favourite of speculators means our currency is especially prone to substantial volatility and corrections. A correction in the currency could occur as soon as market participants lose their appetite for riskier investments and sell their AUD holdings in favour of safer investments.
In this environment, volatility is likely so businesses need to ensure that they properly manage their currency risk. A sudden downturn in the Australian dollar would have a significant impact on importers who, if unhedged, would find themselves paying more for imported products and raw materials. Likewise, exporters who are hedged at current levels would be locked in at a higher exchange rate than necessary.