The Pound Gets Pounded

Will the RBA Cut Rates on Tuesday?

• Foreign exchange markets have had little hard data to trade off in February but lots of speeches by central bank officials. RBA Governor Glenn Stevens spoke last Friday and Assistant Governor Guy Debelle spoke on Tuesday leading to mixed interpretations by the market.
• Stevens’ speech was on the hawkish side, suggesting the RBA was on hold and that an FX intervention was off the cards. Stevens stated that “[there is a] good deal of interest rate stimulus in the pipeline.” He went on to say, “It is not that interest rates are seeking a particular exchange rate response, but they are being set with a recognition of the exchange rate’s effect on the economy.”
• Debelle, however, stated “We still obviously retain scope to lower interest rates further, should the need arise, including to counterbalance the pressures of an elevated exchange rate.” Debelle’s comments drew headlines and were interpreted as a sign rates may be cut in response to the exchange rate, even though he essentially echoed Stevens.
• The RBA have very limited scope to participate in the much publicised currency war. The domestic economy is sensitive to inflation and further rate cuts may see it increase. This is unlike that of Japan, Switzerland or the U.S. economies where inflation is zero or negative. An aggressive devaluation policy like that of the Swiss National Bank would also mean the RBA has to sell AUD and buy large amounts of low yielding USD and JPY, accumulating massive foreign currency reserves. The RBA has little market influence in a currency war against the likes of the U.S., U.K., Japan and Europe and will be forced to the sidelines.
• Steven’s goes on to state, regarding intervention, “The truth is, the power of the forces at work here, you need to be pretty confident that it is seriously over-valued, or the market is behaving in some quite irrational way, before you would launch a large scale intervention.” In other words, the RBA is very unlikely to pursue devaluation; they only seek to reduce volatility in times of irrational market behaviour. The last time this occurred in 2008-2009 was detailed in Debelle’s speech.

• One of the final pieces of 2012 puzzle will be released tomorrow. Fourth quarter private capital expenditure will be released by the Australian Bureau of Statistics and is expected to show 1.1% growth. Simply, the figure measures companies’ investments in capital assets in Australia, and has been buoyed by mining for the last five years. When the RBA refers to in the “peak in mining investment”, it is essentially referring to this figure. 

• A softer than expected figure may mean this peak is beginning to occur sooner than expected. It may also mean that other areas of the economy are suffering, illustrated on the right as manufacturing investment declines and other industries is nearly flat.
• When Glenn Stevens spoke last Friday, he made repeated mention of the cuts already made and the prudence of rates remaining on hold. While the capital expenditure figure will be an important figure, its future trajectory is fairly well known to the RBA, “peaking within the next few quarters”. Given the comments made on Friday, their policy of not targeting exchange rates and no other significant data released in the last month, we don’t expect a policy shift on Tuesday.
• The final piece of the 2012 puzzle quarterly GDP growth will be released next Wednesday. The figure is the broadest measure of Australian economic performance and will be one of several significant risk events for the AUD next week. 

• Please see below for specific currency commentary.

USD

• After a brief flurry above 1.03, AUDUSD moved lower this week as risk sentiment waned and speculation over the Fed asset purchase program were raised.
• On Thursday night, the second estimate of U.S. fourth quarter 2012 GDP will be released. The first estimate was released on January 30^th at -0.1% and the second estimate is expected to revise growth to 0.5%.

• The Federal Open Market Committee (FOMC) released the minutes from its February monetary policy decision. The minutes outlined an increasing number of concerns over the asset purchase program, or monetary easing, expressed by an increasing number of committee members.
• The committee members’ concerns include those over cost of the program, record size of balance sheet, inflationary risks and creation of asset price bubbles. Some members expressed that the program should be adjusted soon in the future. On the other hand, the committee also cited the costs of ending accommodative policy too early. They stated the importance of, “maintaining a highly accommodative stance of policy as long as warranted by economic conditions”.
• Following this, the Federal Reserve Chairman Ben Bernanke also had to defend the Fed’s asset purchase program to the Senate Banking Committee at the Semi-annual Monetary Report. Similar to those expressed by FOMC members, Senators expressed concerns over the risks and costs of the asset purchase program. Bernanke recognised the presence of such risks, but firmly maintained the benefits greatly outweigh these costs.
• Both meetings illustrate the increasing pressure on Chairman Bernanke about monetary easing. The comments led to a pull back in the AUD and NZD in favour of the USD. This is because investors borrow cheap money in the U.S. and invest it in higher yielding currencies like the AUD and NZD. Investors also use these cheap funds to invest in other assets such as shares and corporate bonds, the reason for the concern over asset price bubbles. A sooner than expected reduction in monetary easing subsequently softens risk asset prices and strengthens the USD.  
• Bernanke also voiced his concerns over ‘The Sequester’, automatic spending cuts scheduled for March 1^st. He stated that greater focus should be placed on long term debt sustainability rather than the short term discretionary spending cuts that the automatic sequestration predominantly targets.

EUR

• The EUR weakened further this week as Italy’s elections produced a stalemate and a source of market uncertainty. Mario Monti, the current Prime Minister will not be re-elected as austerity measures have brought him widespread unpopularity.
• No one party holds a majority, but those that hold the greatest number of votes claim to be of the anti-austerity, Euro-sceptic flavour. The front runners include Silvio Berlusconi, a man fighting charges of sex with a minor and tax fraud, and Beppe Grillo, a former comedian who denounces austerity and wants a referendum on the Euro.

• The market reaction has been most pronounced against the traditional safe havens. The EUR has fallen from 1.3434 to 1.3063 against the USD and from 1.2361 to 1.2182 against the CHF over the week. The election risks a reversal of the recent run of Euro zone confidence.
• Last Thursday PMI figures were released for the Euro area manufacturing and services sectors. All figures were worse than expected with only Germany showing industry expansion.

GBP

• Things continue to worsen for the British economy. Moody’s downgraded the country from Aaa to Aa1 joining Fitch in placing it on the second highest rating. S&P are the only agency to keep the U.K. on AAA with a stable outlook. While there are no immediate direct implications, it may increase borrowing costs for the government and British companies.
• AUDGBP rallied to 12-month highs, reaching 0.6840 before retreating to just above last week’s levels.
• The second U.K. GDP estimate will be released tonight with -0.3%, a downward revision may lead the pound lower further.