AUD/USD and OIS Rates

The RBA’s gloomy December Policy Statement reported in the Minutes revealed Wage growth was down, Employment was down, Business Investment down, GDP expected down, Housing Construction down and down for overall Consumption. Meanwhile the economic outlook for Australia’s major trading partners was expected to improve but only led to a slight increase in exports and the majority was service related rather than the important commodity related complex long known in Australia.
AUD/USD dropped September 2016 to December from 0.7773 highs to 0.7169 lows yet AUD traveled back to March highs at 0.7746.
The RBA’s action plan was again, since the August 2016 OCR drop, to institute a non move able 1.5 interest rate for OIS maturities from 30 to 180 days from December and directly after release of December’s minutes to current day. AUD/USD then exploded higher in January to 0.7602, February 0.7741 and 0.7748 in March. The 1.5 interest rate instituted by the RBA offered an enormous opportunity for longs because it established a solid bottom and allowed the market to take AUD to upper reaches.
The 1.5 point was more than AUD higher. Australia contains a serious serious problem in their interest rate alignments and this conundrum is unique yet specific to Australia. Despite the RBA’s many calls to lower AUD and mentioned many times before, its impossible and now quantified for AUD to achieve the desired lower bounds.
As the current system exists, the RBA must either raise OIS rates or allow other vital interest rates to trade lower. This is a tough call and tall order in a well defined Australia money market system. The only other option as was done by Australia throughout its history is allow OIS to freely trade. The further problem to AUD is misaligned Correlations to economic announcements.
December’s statement was horrid yet 1 month later, AUD was 600 pips higher. Glenn Stevens mentioned many times how Commodity prices were misaligned to AUD. Commodity prices traveled lower yet AUD went higher. Economic conditions lower yet AUD goes higher. GDP down, AUD higher. November’s election saw AUD correct from 0.7700’s to 0.7300’s then back higher she went. Terms of Trade increased based on February’s statement, AUD roamed 200 pips while Commodity prices went higher and AUD/USD roamed. Yesterday AUD/USD broke vital 0.7597 yet it traveled higher. The interest rate system is aligned for AUD/USD higher, never lower.
Then the next problem is misaligned interest rates causes a serious off kilter Correlation from AUD currency pairs. The December statement mentioned AUD/JPY was higher. Misaligned and negative Correlations from AUD/USD to AUD/JPY is almost permanently built into the system as well for AUD/NZD, AUD/CAD and most vital to Australia trade in AUD/ASIA pairs. AUD/JPY is actually an old reliable negative correlation to AUD/USD while AUD/CAD and AUD/NZD revolve from positive to negative then back again. AUD/CAD and AUD/NZD require constant correlation monitor as both might travel together in any given day or week to AUD/USD or travel against.
AUD/CHF is the only reliable and steadfast Correlation to AUD/USD. View AUD/USD and the second pair in the line ups as JPY, CHF and CAD then one can see the opposites to AUD yet CAD, CHF and JPY belong to the same USD universe. As opposites, AUD/USD should easily correlate to high 90% degrees to AUD/CAD and AUD/JPY especially AUD/CAD because its a risk barometer currency pair. Instead, AUD/USD lacks a corelational pulse.
A fully functional system occurs when the main pairs and in this case AUD/USD has full Correlational control to its cross pairs. AUD/USD is at a complete disconnect to its exchange rates, its economic releases, and to the main 1.50 interest rate. Normally when the main pair lacks correlations to its cross pairs then the main pair drops significantly but not AUD/USD, it goes higher.
What explains the correlational disjunctions across currency pairs derives strictly from the RBA side and again the system of interest rates. The big movers in order are AUD/NZD, AUD/CAD and AUD/JPY. While cross pairs must price above the main pair, AUD/USD’s main cross pairs barely price higher than AUD/USD and AUD/CHF is the exact pair as AUD/USD. The system gets interesting when viewed from under priced AUD/EUR as its price always remains below.
The argument to AUD/USD from the RBA side of interest rates is exchange rate protections were built into the system to force price containment rather than allow a market price to develop. Viewed from reciprocals then price containment is clearly evident which translates to day to day volatility at a disadvantage. Without protections, AUD pairs would seriously move everyday. Yet certain protections are required. If AUD/EUR wasn’t protected, EUR/AUD volatility would explode on a daily basis to see hundreds of pips trade on any given day. What protections led to however was a lost currency pair in AUD/USD as the main exchange rate.
The impression from many prior statement reads is the RBA is confounded by AUD movements as if they don’t understand AUD triggers to movements. The RBA in all statements report on Trade Weight Indices and views AUD in percentage terms to its trade partners. If AUD moved 1 or 2% then it seems no big revelation and assumes all is well. I suggest the RBA study the ECB or its counterpart in the RBNZ.

 

Brian Twomey

 

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