Sonia: Levels, Ranges, Targets

Upon the Brexit announcement, Sonia in monthly average terms dropped from 0.4577 to 0.2478. At the August 2008 crisis, Sonia dropped from 0.8973 to 0.5224. Sonia’s overall slide began in Oct 2007 at 5.7751 and since, Sonia never looked back as it trades today at 0.2141. Since Sonia’s 1997 introduction, it traded lifetime highs at 8.60 in April 1998 but only for 1 day.
The sidebar issue is at Sonia 0.89 during 2008 crisis time, GBP/USD traded 1.98 and it appears the exchange rate was deeply misaligned to the interest rate. OCR and AUD/USD suffer the same consequences today. Against Sonia reforms, GBP appears, appears aligned correctly. Libor as the overall driver to GBP in 2008 was possibly misaligned.

Sonia currently trades between the 1 and 2 year monthly averages from 0.2119 to 0.3179. Next averages above at the 3, 4 and 5 year monthly comes 0.3613, 0.3772 and 0.3876.

At 0.30 bumps against current UK CD rates. At present 0.30 is down from July 2016 at 0.35. How vital is the drop to 0.30 is 0.35 CD’s traded from August 2016 to July 2016 then came the current drop at 0.30 since July 2016.

Below 0.2119 then daily Sonia must be viewed. For the past week, daily Sonia traded 0.2100 to 0.2400.

Sonia targets from monthly averages 1 to 10 years and every successive month range from 0.1954 at the 2 year to 0.3336 at the 8 year monthly average. Sonia is most oversold from the 6, 7 and 8 year monthly averages.

Why longer dated averages is current 4th Quadrant since 2008 runs 12.5 years with a mid point at 6.25. The point at 6.25 is a cycle, period average and overall driver to current Sonia as well as all market prices. The 6, 7 and 8 year averages are located at 0.4048, 0.4214 and 0.4277.

The 10 year is located at 0.9876 and is overall am irrelevant average as well as the 9 year at 0.5108.

Inside Sonia’s price is a Signal and currently far far to high. What drives far to high is new overnight rate reforms hold rates in tiny ranges. The price is contained and for now.

If an implosion ever hits markets, overnight rates will travel to exhorbitant levels. Its a location dilemma that drives the signal as overnight rates lack ability to trade at their proper levels. If a signal is to high, it means inside current price is nothing as the price just wanders and is completely lost. It needs variation in order to relieve the high signal conundrum. All overnight rates in every nation suffer the same effects. But other maturities as well are under the same dilemma. Interest rates are misplaced. If interest rates are misplaced then exchange rates and all market prices are misaligned. The signal dilemma is a constant from 1 to 10 year averages.

Sonia under current BOE guidance is undergoing  a massive 3 year reform and completes April 2018. Can the BOE raise or even lower Bank rate under such a reform. My answer is no way as far to much is invested to see reform end dates.
What is expected from Sonia is more of the same dead trading ranges.

Brian Twomey

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Sonia Reform Update

 

 

The main reasons for 2014 central bank reform of overnight rates was first to alleviate the depedence to Libor as USD $350 trillion is concentrated inside Libor Contracts. The idea was to create an alternative benchmark specific and conducive to each nation’s money markets so to drive liquidity away from Libor. Central banks created, as an alternative to Libor, overnight rates to become Risk Free Interest rates.

The second concept since adopted by all central banks is ability to create a longer dated term structure by risk free rates as alternatives to what central banks viewed as an unstable and low volume Sonia – OIS. In Sterling markets for example, the vast majority of Libor – OIS trades were short term therefore adoption of Sonia as the new risk free rate would allow longer dated trades along the term structure.

Consider Friday’s Libor OIS rate was 0.0130 vs Thursday at 0.0114 while Friday’s 3 month Libor – OIS was 0.1786. Central banks view the spread as far to wide as the net result to risk free rates is proposed to hold tigher ranges.
A bank in financial trouble under Libor contracts was considered to big to fail but as the shift away from Libor materialized then the bank may Fail safely.

The manner to hold Sonia in tighter ranges at current proposals until the final Sonia announcement in April 2018 is to employ a Trimmed Mean to the Volume weighted mean rate. Reformed Sonia is expected to then trade 1.3 basis points below current Sonia. April 2018 falls directly between March and May 2018 BOE scheduled meeting dates.

Volume will calculate at the 10th, 25th, 75th and 90th percentiles as is similar to Fed Funds by calculations at the 1st to 99th percentiles.

As an example, Sonia traded 0.2123 September 1st. As Reformed Sonia, the rate would’ve traded at 0.2014. The 10th, 25th, 75th and 90th percentiles traded from low to high at 0.15, 0.18, 0.22 and 0.23.

August 31, Sonia traded 0.2109. As reformed Sonia at 0.1946, the corresponding percentiles factor to 0.15, 0.17, 0.22 and 0.23 at the 90th percentile.

Fed Funds in comparison traded 1st to 99th percentiles Friday from 1.14, 1.16, 1.17 and 1.25 at the 99th percentile. Volume was 86 billion, down from last week’s high at 91 billion.

Expected in Sonia is far higher trading volumes to roughly GBP 40 billion daily or 52.74 billion USD. Current daily trading volumes from March to May achieved GBP 17.5 billion and the highest since Setember 2011. Interesting is actual number of trades factored to reform Sonia jumps from 341 to 357. Australia in OCR markets trades roughly 25 to 50 transactions on volume at AUD 4512.

For context, the Federal Reserve chose the secured Treasuries Funding Rate as its Libor alternative. The current rate is 1.00. The Swiss at the SNB chose Saron as its secured rate for its Libor Alternative while the Japanese chose its unsecured, uncollateralized Call rate. Saron traded Friday at minus 0.74 or 0.26. Japanese Call Rates traded Friday minus 0.041 or 0.959. The range traded minus 0.070 to 0.001. This translates to 0.93 to 0.001.

Brian Twomey

Fed Funds and Taylor Rules: January 2017 to October 2017

As John Taylor is considered for a Fed position on the Board, a check on his invention to his 1997 rules as his rules replaced central bank’s preferred and widely employed Monetary Condition Indices.

 

Two methods to view Taylor Rules. The first, 0.5 in the first formula is employed as the Coefficient to hold the balance throughout the full calculations. Current Inflation is also employed rather than the second method to use 1.5 and Inflation Target of 2.0%. Both are valid as a view into not only Fed Funds and levels but the Output Gap measured by GDP minus GDP is at current 0.2 and trades above Inflation at 0.1. The current Out Put Gap at 0.2 is extraordinarily low and matches against January 2017. All 2017, the Out Put Gap hasn’t changed.

 

To use the 90 day rate at 1.07 for the first formula then current Fed Funds should be at 1.18 and its close to the current 1.16 close price over the past months. To use actual 1.16 Fed Funds then the current rate should be located at 1.27. The range overall, 1.18 to 1.27.

 

To use the second method as is the way for the RBNZ at 1.5, the 2.0% target and 90 day interest rate then FED Funds should be targeted at 0.657. What 0.657 represents is support for the 1 month interest rate as it closed today at 1.07. This is Yellen’s Floor for Fed Funds and must rise to see any shot to raise. But the Output Gap must move higher.

 

Here’s what we’re working with in the first method.

Current PCE + 0.5 X ( Inflation minus Inflation) + 0.5 X ( GDP Minus GDP) + Interest Rate. Inflation 1.8 minus Inflation 1.7 = 0.1 while GDP 2.20 minus GDP 2.00 = 0.2. Today’s 90 day close at 1.07 factored offers Fed Funds at 1.18 while actual Fed funds used offers 1.27. For context, the 10 year real yield factors to 0.57 while 10’s minus 2’s equals 0.78. The 10 Year minus 3 month equals 1.20. Doesn’t speak much regarding a raise anytime soon.

 

The second Method Fed Funds target = 90 day + Inflation target + 1.5 X (Inflation minus Inflation) + 0.5 X ( GDP Minus GDP ). Here we have Fed Funds at 0.657 so overall range 0.657 to 1.07 roughly.

 

Comparison October 2017 to January 2017

 

To use the 90 day rate at 0.51 for the first formula then current Fed Funds should be at 0.69 and close to the current 0.66 close price over the past months. To use actual 0.66 Fed Funds then the current rate should be located at 0.84. The range overall, 0.69 to 0.84.

 

To use the second method as is the way for the RBNZ at 1.5, the 2.0% target and 90 day interest rate then FED Funds should be targeted at 0.46.

 

For context in January, the 10 year real yield factors to 0.88 while 10’s minus 2’s equals 1.27. The 10 Year minus 3 month 1.97. Doesn’t speak much regarding a raise anytime soon.

 

The 10 minus 3 month spread dropped 77 basis points from January to October while the 10 to 2 year dropped 49 basis points. The Real yield dropped 31 basis points.

 

The 90 day rate in January was 0.51 and today is 1.07 for a 56 basis point jump. Fed Funds January 2017 was 0.66 and today 1.16 for a 50 basis point rise.

 

The Out Put Gap remains stagnant for 9 consecutive months and the overall concern as every central bank policy remains focus to protect bottoms while not to consider the future economics. The small channel is roughly 50 basis points and this won’t bring economic prosperity.

 

Brian Twomey, Inside the Currency Market, btwomey.com

USD/JPY MA’s: Levels, Ranges, Targets

USD/JPY longer term averages from 2897 day to 4812 crossed above shorter averages from 1874 day to 2642. The longer term averages sit from 101.16 lows to 106.53 at the January 1, 1999 high and 4812 day average.

From USD/JPY’s close at 111.82, next supports are located at 111.74, 111.24 then 110.36 at the 1104 day and 109.47 at the 337 day. The 1279 day, 5 year average at 107.75 is crucial as this area begins many massive clusters of supports in the 106’s starting from 106.53 at the 4812 day, 106.21 at the 4688 day, 106.10 at the 4432 day and 106.04 at the 1359 day. The levels at 110.36 and 109.47 overall are most important as breaks here represents wholesale changes to USD/JPY.

The most vital breaks above are located at 112.79 and 113.22. USD/JPY is massively oversold from current 111.82 against all averages and becomes more oversold against further price drops.

The 18 year midpoint from 113.22 to 98.23 is located at 105.72 and coincides to the 4177 day average at 105.61. A break of 110.36 then the mid point becomes 104.29 and coincides perfectly to the 3923 average at 104.29. From 112.79 to 98.23 then the mid point factors to 105.51 and again confirms the most vital point overall at the 4177 average at 105.61.

Above from 113.22 to 111.24, the mid point factors to 112.23 and just short of the 112.79 break at the 594 day average. For perspective, the mid point from 112.79 to 111.24 is located at 112.01. At 112.79 will be USD/JPY’s toughest break and as well it sits at the upper 18 year range point.

The noted point to 111.74 is it represents a specially designed moving average and it coincides perfectly to market prices. The overall ranges for USD/JPY is found from 112.79 to 110.36. Most vital to the upside scenario is 111.74 as a hold at this interval then 112.79 contains a shot while a break of 111.74 then views 110.36.

As central banks restructured prices in currency and other associated markets, 24 hour ranges factored ahead become predictable. For Monday trade, USD/JPY will range from 111.26 lows to 112.91 highs. In the way of 112.91 is a break point at 112.79 and range point at 112.85. A range point in currency trading is far more vital than a trade able level and a target. The next vital break at 112.79 is protected while 111.74 is vulnerable.

Japanese Overnight Call Rates traded September 10 as of the last post at -0.046 or 0.954 and closed Friday at -0.021 or 0.979 for barely a 2 basis point difference.

While the BOJ remains committed to bond buying stimulus against its yield control policy to contain the 10-Year yield as well as negative interest rates, the proposed Consumption tax slated for October 2019 is a warning.

All past Japanese economic experiments failed as a result of an economic tax. In the 1980′ to 1990’s, the Sales tax impaired the recovery. In 2010 and 2011, the 10% Sales and 10% Dividend tax impaired the recovery. In 11 Japanese economic experiments since the 1940’s, the tax failed to see the economic experiment come to fruition.

The Japanese never met a tax they didn’t like and its the commonality to every experiment since the 1940’s and as well far back to the 1930’s when USD/JPY was pegged to GBP/JPY to gain access to London Gold markets. The 1980 to 1990’s experiments was most wild as USD/JPY was pegged to GDP and the money supply. Wild volatility was seen in USD/JPY as money supplies swung far and wide.

As a result, GDP for fiscal 2017 based on BOJ forecasts are slated for 1.5 to 1.8, then 1.1 to 1.5 for fiscal 2018 and 0.7 to 0.8 for fiscal 2019. Fiscal years for the BOJ are located in budgets years from April to April.

The overall problem to USD/JPY is its associated averages lack uniformity and certain averages are misplaced such as 109.47 and 113.22.

Following are averages and line ups then followed by comparison averages for September 10.

80 day = 111.24
Special average = 111.74
337 day = 109.47
Close – 111.82. Call Rate = -0.021 or 0.97
594 = 112.79
849 = 113.22
Close 111.82. Call Rate = -0.021 or 0.97
1104 = 110.36
1279 = 5Y = 107.75
1359 = 106.04
1616 = 101.68
1874 = 99.13
2131 = 98.23
2386 = 98.31
2562 = 10Y = 98.92
2642 = 99.50
2897 = 101.16
3153 = 102.27
3411 = 102.62
3590 = 14Y = 102.92
3668 = 103.21
3923 = 104.29
4177 = 105.61
4432 = 106.10
4688 = 106.21
4812 = 106.53 = January 1, 1999

September 10 Average line up

81 day average = 110.93
XXX = 110.29 = Special average
337 day = 109.16
595 = 113.29
850 = 112.92
1105 = 110.08
USD/JPY current close 107.82 Call Rate = -0.046 or 0.954
1279 = 5y = 107.10
1360 = 105.42
1616 = 101.20
1875 = 98.85
2132 = 98.05
2643 = 99.61
2897 = 101.17
3153 = 102.24
3412 = 102.61
3669 = 103.26
3924 = 104.37
4178 = 105.67
4432 = 106.07
4689 =106.26
4787 = 106.50 = Jan 1, 1999

The average for the current line up minus the 5, 10 and 14 year averages is 105.22 and 105.61. To include the 5, 10 and 14 then the averages drop to 104.97 and 104.95.
For September, the averages were 105.62 and 105.87 and included the 5 year average.

Brian Twomey, Inside the Currency Market, btwomey.com

G10 and Catalonia: Levels, Ranges, Targets

Catalonia’s end result  is Pokemon decides to negotiate withdrawal  / Independence terms against a government  to which subjugated Catalonia for 1000 years. What separates Catalonia from Spain especially from the populations historically is Catalonians are not warriors as was seen from the Spanish police in dump of ballot boxes and billy clubs to voters.

What was seen was the rank and file of Spain hasn’t changed since the Arab armies left Spain in the 1500’s, since Christopher’s Columbus crew was placed on trial for many crimes committed against the people of Hispaniola, since the many crimes committed in the 1700’s against the populations of Florida in the United States. God speed to Catalonia yet I view negotiations with Lovejoy as skeptical.

Catalonia can add another claim to its rich history by introduction to the Spanish speaking world its Castillian language. I believe this refers to the Vosotros Vs Nosotros forms inside the language. It separates Spain speakers from the remainder of the Spanish speaking world.

Currency markets began the week against vital break points for many pairs and price drivers from the 20 day average. EUR/USD is challenged by a current rising line at 1.1699, GBP/USD broke above current 1.3107, AUD/USD remains  challenged at 0.7808 and NZD/USD at 0.7180.

USD/JPY sits just above its vital lines at 111.78 and 111.21 while USD/CAD faces 1.2601 and 1.2629. Its do or die for our currency pairs to make the move as break points inform neutrality  rules current prices.

 

Brian Twomey

Catalonia, GBP and EUR

Catalonia dates not only its history to the 11th century but the movement to become independent also dates its background to its early beginnings. The word is irredentism as the Catalonians fought for 1000 years to be free from Spain. The Catalonians are clearly correct in the current fight for independence and every person in this world should yell from rooftops to Catalonia’s success. The great city of Barcelona has withstood the test of time continuously as a thriving economic city and vital sea port.

 

As Spain was ruled by Arabs from 700 to 1490’s, Spain’s subjugation of Catalonia was forced upon the people to gain access to Barcelona as the only available seaport, to ensure the spread of Catholicism, to gain territory and elicit support of fighters against Arab armies. As Madrid was landlocked and the greatest battles were fought for the sea port city of Valancia and Granada in the South, Catalonia also served as a possible escape route to France if the Arabs wrested full control of Spain. The move to take Catalonia was forced as a defensive move.

Through a series of many events over 1000 years since the 11th century, Catalonia never lost sight and fought continuously for its right to independence. Today’s independence vote is another event in a long line of attempts against Spain’s domination.
The arguments against independence due to lack of a central bank is a specious argument as Australia and New Zealand operated for 300 years through its Treasury departments before and after statehood. Australia became a state in the early 1900’s and formed its central bank, the RBA, in the 1960;s. Catalonia requires 1 bank as designated to issue bonds and finance the new government. Catalonia uses the Euro so no problem here.

The issue for Catalonia is political not economic as the stated figure is 10% of Spain’s GDP is provided by Catalonia. Yet Catalonia’s parliament and its own political system is already established since the 1920’s. Catalonia only requires the yes to independence vote and its on its way to statehood.

GBP/USD as mentioned in yesterday’s post would see 1.3200’s by an out of sync news release. Manufacturing today was reported higher than expectations , 2.8 Vs 1.9 expected Y vs Y. GBP bolted to 1.3202 then retreated to current 1.3180’s.

What is 1.3202 is quantified by today’s break points above at 1.3195, 1.3201, 1.3226 and 1.3252.

EUR/USD faces a rough road at first 1.1809, 1.1837 and 1.1853.

Will EUR/USD drop miles in a Brexit or EUR/CHF scenario upon a positive Catalonia vote. Nope, no changes.

 

Brian Twomey

GBP/USD, GBP/JPY, EUR/USD and USD/CAD Break Points

 

The common theme and drivers for the week’s currency prices are 20 day averages which means fairly normal price moves inside fairly normal volatility. If 5 and 10 day averages drove the price system then flat prices would rule the day with a view to breakout prices in days ahead.

GB?/USD today contains vital break points at 1.3131 and 1.3055 Vs Sunday open at 1.3051 and 1.3129. The range today fell 2 pips in overnight trading from 78 pips to current 76 pips. GBP at 1.3148 trades above 1.3131 and this day’s next upper break point at 1.3137. Next on the agenda above is 1.3161, 1.3194 and 1.3227.

Below 1.3137 and 1.3131 comes next vital breaks for this day at 1.3084 and 1.3061 which informs 1.3055 holds. Over next days and for MA traders, the 20 day at 1.3392 is vastly oversold at current prices and targets 1.3250’s.

What decides 1.3250’s are two vital points. The first is GBP/JPY as the only pair in the GBP universe to maintain over long periods a solid and positive correlation to GBP/USD. Without GBP/JPY correlation support, GBP/USD prices would trade far lower. GBP/JPY sits on solid supports at 146.72 and 145.15. The 20 day average at 150.35 like GBP/USD 20 day is vastly oversold.

Most vital to both GBP/USD and GBP/JPY is on the UK interest rate front as the BOE is currently protecting bottoms and preventing significant rises in normal market trading. The protections are vital because its non characteristic for the BOE which informs a current concern to exchange rate prices. Normally central banks and the BOE in particular allow price movements. The 1.3200’s based on the last weel’s interest rate curves will be tough tough breaks for GBP/USD.

What normal trading refers to the assumption UK and USD data maintain forecast release. Out of sync forecasts then a more significant move will be seen.

Why the BOE concern is due to lifetime trading lows for Sonia as well as UK repo rates. Lifetime lows mean Sonia since 1997 and Repo rates since 1963. Current UK interest rates are dangerously low and this point alone may force the BOE to raise. QE at 400 million is not as vital a concern as much as the low interest rate.

To view GBP/USD’s complement EUR/USD, it sits just above vital break points at current 1.1684 and 1.1646. At 1.1684, it rose 6 pips in overnight trading.

Further is a reinforcement view from USD/CAD on the USD side as current price sits just below its break point at 1.2619 yet today only CAD faces massive break points above at 1.2561, 1.2569 and 1.2611. For CAD today, 1.2619 holds.

While 20 day averages currently drive prices from as MA perspective, the vast majority of currency pair prices are on the verge of signiicant breaks yet for today, interest rates inform today is not the day to see those breakouts.

 

Brian Twomey

Australian Dollar: Resilience of a Country and Its Currency

Australian Dollar: Resilience of a Country and Its Currency

Australia: The Early Years

New South Wales was founded in 1770 by British explorer Captain James Cook, given its formal name and established as a legal colony in 1788. Later in 1863, the British separated the land to form further British colonies of Tasmania, South Australia, New Zealand, Victoria, Queensland and the Northern Territory. Founded inside the borders of New South Wales is today’s capital, Canberra and most important city Sydney and would become vital components to Australia’s legal declaration as a nation in 1901, Australia’s central bank and AUD as a single free float currency. But the road for Australia to become the nation and currency we know today was not an easy journey.

 

Imagine the early explorers revelation when they found New South Wales and Australia in particular with an abundance of natural resources such as Coal, Iron Ore, Tin, Nickel, Bauxite, Copper and later Gold, Silver, Natural Gas and Petroleum. Iron Ore was the first suspected resource identified by Captain Cook when his compass failed in many locations. He also found “not sand but deep black soil capable of producing any type of grain.” The problem wasn’t the natural resources but the system of trade.

 

Early year complications included not only lack of banks and a central bank but a system of exchange and various currencies employed as a system of trade found severe shortages because currencies left the territory by way of merchant ships and residents spent currency only when the need arose. Various currencies deployed between 1780’s – 1814 was the Indian Rupee, Dutch Guilder, Spanish Real, British Sterlings (Silver Pennies as the formal name) and internal barter of natural resources: Copper and Rum. Early Notes of credit termed Police Fund Notes and backed by the English Treasury were issued by banks but fear was notes were subject to and found counterfeiters. Police Fund Notes were just one type of note issuance during this period and all found problems. Not until the Spanish Holey Dollar became the first ever minted and legislated coin did Australia enter a new period because confidence was instituted in a currency with not only Government backing but a fractional dimension was introduced to understand a currency value to formally trade goods.

 

The New South Wales government under then and well known Governor today, Lachlan Macquarie purchased 40,000 Spanish Reals due to the Real’s world dominance then and cut the center from the Reals to double the number of available coins. The coins were formally minted and known as Holey Dollars with official Australia backing and began circulating in 1814. The center of the coins became known as Colonial Dumps and were fixed at 15 Pence per Dump while the official Holey Dollar was Fixed at 5 Shillings per Holey Dollar. Again, shortages developed due to increased natural resource trade and growing populations so in came the British as they imposed the Sterling Standard throughout its vast empire.

 

The British relieved the shortage pressures and 40 year attempt to institute an exchange system by legislating a Sterling currency in 1825 although accounts specify brisk trade of Sterling occurred as early as 1822. As the British introduced a new Gold piece and imposed the Gold Standard in 1821, all nations under its vast empire were subject to the new Sterling Standard. Australia was a prime target so approximately, 30,000 Pounds Silver arrived and it was here that began Australia’s long, long history as the Australian Pound that would span about 150 years. The term “about” was stated because evident throughout Australia’s history, legislation was always late to actual currency and other market developments. Changes in early Australia occurred as people movements or from those market participants that wished for adjustment so all demanded corrections from Australia’s government.

 

Quite evident from modern day Reserve Bank Governor speeches from 1960 to present day is Australia is not only a very conservative government traditionally but market adjustments occurred slowly and gradually with a need for consensus from government representatives. Consensus took time particularly in Australia as spirited political debate was always the norm and dates its history from its early beginnings. Legislation was never forward, it was always a response to market developments that were already implemented. With formal recognition of RBA true independence by Australia’s government in 1996 and with full powers to fully implement monetary policy independently, the ties between the RBA and Australia’s Treasury Department was severed.

 

From 1825 until the 1966 decimal system was introduced and Australia’s end to the Pound Fix in 1967, the Australian currency was known as the Australian Pound. Official RBA accounts always addressed the Fix end as 1971 but 1967 began actual market trading with price swings from 1967 onwards. AUD/GBP would share a 150 year relationship. Two problems existed however, Australia wasn’t formally a nation and official adoption of a currency wasn’t legislated. The impetus in this relationship was Gold.

 

Gold was found in the 1850’s and prosperity came to Australia. Banks were formed, populations grew and Gold coins were minted backed by Gold in circulation. Australia’s Museum of Currency Notes reports the population tripled to 3 million between 1858 and 1889, and banks saw an explosive increase. In 1851, 8 trading banks (Commercial Banks, traditionally referred as trading banks by Australia) and 24 branches existed but by 1890, 33 new banks opened accompanied by branches that exceeded 1500. As depression occurred in the 1890’s due from credit booms, many banks failed but reopened later after Australia became a nation in 1901.

 

As Australia’s six self governing British colonies voted and approved Federation, a constitution ratified by the English Parliament in 1900, a new nation was born in January 1901 when Australia adopted and called the new nation: Commonwealth of Australia. The new Commonwealth would include New South Wales, Tasmania, South and Western Australia, Queensland and Victoria. The first Parliament would convene May 1901. The first acts of the new parliament were adoption and issue of a currency and notes with full government backing.

 

AUD History

From 1910 to the 1983 free float, AUD journeyed through first the Fix to AUD/GBP, Fixed to USD, Fixed to its TWI (Trade Weight Index) then Fixed as a Crawling Peg to the TWI basket. Finally in 1983, the free float began and the free float was purely a clean float.

 

Formal adoption of AUD – adopted but not Fixed to GBP – occurred with passage of the Australian Notes Act in September 1910 and the Australian Notes Tax Act in October 1910. The first ever official notes were issued in 1913 based on the British system where 12 Pence = 1 Shilling and 20 Shillings equates to 1 Pound. A 10% per annum or as the legislation states 10 Pounds per Centum tax was imposed on all bank notes issued or reissued by any bank in the Commonwealth. Consistent with Section 51, Subsection 12 of Australia’s constitution, the powers to coin and issue was placed under government Treasury Departments. No mention of a central bank and it is here why the RBA was not only slow to develop but slow to gain its independence once it was formed due from Treasury constitutional dominance.

 

AUD/GBP

AUD/GBP from March 31, 1919 to August 31, 2014, the historic trading range saw its lowest low at 0.3333 on December 31, 2001 and highest high on December 31, 1976 at 0.7824 with an opening price that day of 0.7458. Not only were both prices extreme rarities throughout AUD/GBP’s history but other Fix periods accounted for those price swings.

 

The formal AUD/GBP Fix occurred June 30, 1931 at 0.3846 with a more formalized Fix one year later June 30, 1932 at 0.4000. The original 0.3846 Fix during this period means opening, high, low and closes remained the same price at 0.3846. Breakdowns in the Fix first appeared March 31, 1932 as the market was moving towards the 0.4000 point. The 0.4000 point held as open, high, low and close from September 30,1932 until June 30, 1947, 15 years.

 

A new Fix then developed September 30, 1952 at 0.3984 and held until December 31, 1967, 15 years. AUD/GBP trading ranges in the interim period from 1947 – 1952 hardly saw a 10 pip move on any given day. From June 30, 1931 – December 31 1967, AUD/GBP didn’t move nor saw a 10 pip price change on any given day in 36 years. Responsibility for price movements was placed on Gold and Deflation.

 

AUD/GBP from March 31, 1919 – 1931 Fix saw trading days of 20, 50 pips and a rare day March 31, 1920 at 441 pips. June 30, 1924 was another rare 123 pip day. The exchange rate was very stable between 0.4900 – 0.5200 but it was obvious June 30, 1930 the market was moving towards another period when AUD/GBP broke its 0.4900 range and opened the next day at 0.4700’s and then moved steadily down towards the 1931 Fix at 0.3846. The conundrums during this period were many but all involved GBP and the UK rather than Australia.

 

If AUD/GBP traded between 0.4900 – 0.5200 then GBP/AUD ranged between 2.0408 – 1.9230. If AUD/GBP was moving towards the 0.3846 Fix then GBP/AUD was moving up to 2.6000.

 

The period from 1870’s until 1931 was characterized as the Gold Standard where currencies were valued based on Gold prices. GBP left the Gold Standard in 1914 and 1916, returned in 1925 and formally left permanently in 1931. The explanation to spikes in AUD/GBP was characterized as times when GBP suspended then reentered the Gold Standard. The 1925 event was an actual devaluation of GBP/USD to its pre war rate at 4.86 and was called for by Churchill. When GBP permanently left the Gold Standard in 1931, all currencies free floated with wide price swings on any given day that ranged between 500, 1000, 1500 and even 2000 pip trading days.

 

The UK saw higher exchange rates coming in times when serious deflation, deficits and debt was the order of the day for many nations due from World War 1. To retain the Gold Standard wasn’t the way to assist to alleviate its many economic problems due to small movements in exchange rates versus Gold.

 

What the UK didn’t see during this period was all nations suffered serious economic effects and had acceptable exchange rate prices for their currencies to export goods and regain economic health. This led to true currency wars where nations engaged in destruction of the next nation’s exchange rate to gain export advantage. The Tripartite Agreement was signed in 1936 by all nations and all agreed not to engage in “Competitive Devaluations” of the next nation’s exchange rate. The UK devalued twice more during Australia’s Fix period. In 1947, GBP/USD was devalued 30% from 4.03 – 2.80 while Australia revalued AUD/GBP higher to 0.4600’s. In 1967, GBP/USD devalued yet again and it was here where Australia ended its Fix to AUD/GBP in favor of its next period.

 

For Australia and the AUD/GBP Fix period, it can only be classified as smart, yet protective and possibly defensive. If a currency is Fixed, it means budgets are also fixed at specific levels. But just as GBP went through devaluations Vs USD, Australia was fighting another battle with USD because AUD was also fixed to the United States Dollar.

 

AUD/USD

Officially, AUD/USD was fixed to USD from 1945 – 1971 and became the center of RBA Monetary policy during this period because RBA policy was adjusted based on USD monetary policy to protect the exchange rate. The Fix period ended December 30, 1971 but the start date is questionable because more than one Fix price was observed throughout the early 1940’s. The key to understand the early and middle 1940’s is the Bretton Woods Fixed exchange rate to $35 per ounce Gold system was signed in July 1944 and implemented so the market possibly was pricing various peg adjustments. Consider as well Fix prices were only allowed a 1% deviation fluctuation above or below by Bretton Woods agreements.

 

From 1940 to 1943, the Fix price was 1.6100. 1943 – 1945 saw a Fix price of 1.6080. 1945 – 1949 experienced another 1.6100 Fix while 1949 – 1971 set the Fix at 1.1200. From 1949 until 1971, AUD/USD traded somewhere not far from 1.1200 but spent most of its life at 1.1100’s. Because of the Fix Pegged system beginning about 1940, exchange rate prices saw again 20 and 50 pip trading days for 31 years. To understand the context for Australia, the early years must be viewed.

 

From 1919 until June 30, 1931, AUD/USD ranged from 2.4300, 2.2200, 2.2300 and eventually winded its way down to 1.8000 by June 1931. Then the Fix prices at 1.6100’s began in the 1940’s. From 1919 to 1931, price swings of 500, 1000, 1500 even 2000 pips per day were common. If the 2.4300, 2.4000 highs are considered from 1919 and 1920, AUD/USD has embarked on a 95-year downtrend if today’s 0.9300 price is further considered.

 

AUD/USD and TWI

 

As the Gold Standard was lifted formally by the 1971 Smithsonian Agreement in December 1971 and officially in 1973 by United States President Richard Nixon, currencies again free floated after a 33 year hiatus. Nations then began adoption of Trade Weighted Indices to understand prices of their own currencies versus other nations for import and export and contractual purposes. AUD was fixed daily to the US Dollar based on its Trade Weight Index number then to the trade weight basket as their next experiments. But as a reminder from Australia’s early days when currency shortages occurred, Australia maintained an Exchange Control Policy. Limits were placed on a number of shares owned by foreigners, restrictions on foreign owned financial companies, import and export controls, registration of foreign banks, foreign currency amounts crossing borders. When AUD free floated in 1983, all Exchange Controls were lifted that derived primarily from the Banking and Foreign Exchange Regulation Act of 1959. The primary message to markets, investors and the world was capital controls were lifted and Australia was open for business.

 

AUD/USD was next Fixed daily to USD based on its Trade Weight Index from officially September 1974 – 1976. The Fix period began in 1974 at 1.4825 and saw lows of 1.0005 but when the time ended is unknown because of the massive swing in prices and because the period ended only to roll into the next TWI Fix period. End time speculation derives from the 1976 Fraser Government’s desire to devalue AUD against Treasurer Keating’s objections. A long fight ensued regarding devaluation with a win for Prime Minister Fraser but how much and when the devaluation occurred is not seen in the markets. A view of trading days during this period fails to reveal a sustained Fix price based on open, high, low and closing prices. What was seen only was large price swings daily. Part of the price swing reasons may be due to ending of Bretton Woods and abandonment of the Gold Fixed Peg system in 1973.

 

The TWI experiment ended in favor of the Fix to the larger TWI basket. This would be termed a variable or Crawling Peg. The Crawling Peg would become the mainstay system from 1976 until AUD/USD was formally free floated December 1983 at 0.8975. RBA head Glenn Stevens in a 2013 speech credits the free float price at 0.9000. The 1976 Fix saw price swings on any given day at about 500 pips.

 

From Pound to Dollar

 

Formal separation as the Australian Pound was completed in 1966, with passage of the Currency Act of 1965 from Pounds to the present name Australian Dollar. Shillings, Pounds and Pence were converted to a new 100 cent decimal system with a conversion rate at unofficial estimates of 2 AUD = 1 GBP. Since Australia’s Monetary Policy was closely tied to USD, it was also vital to Australia’s economic health to price AUD higher than USD.

 

AUD/USD The Free Float

 

After 203 years since Australia was founded in 1770, AUD free floated and allowed for the first time in history that monetary policy was not set by exchange rates. Early free float years however was characterized as holding AUD/USD’s values.

 

RBA Free Float Interventions

The early years of AUD/USD were characterized as interventions particularly 1989 and 1990 when the RBA intervened 145 and 111 times but serially spread over the years. In 1989 for example, the RBA intervened in 11 of 12 months and over a series of days. June 1989 saw 18 interventions, September 1989 saw 19 interventions. This pattern would repeat itself throughout 1990. Factor 253 United States trading days and 254 for Australia, the RBA was in the market over half of the trading days in 1989 and almost half of every trading day in 1990. The first intervention occurred in 1985.

 

Based again on the 2013 Stevens speech because RBA intervention data dates to 1989, the first major intervention occurred November 1985 then July 1986 “when AUD/USD fell 38% in 18 months and threatened to fall further”. The third intervention occurred the following year in January 1987.

 

The 1980’s were classified as volatile because the Plaza Accords were agreed and signed in September 1985 to depreciate the US Dollar, and Australia was neither a signatory nor invited to the talks because it wasn’t a member of the then G-7 nations. The G-7 nations reconvened two years later to sign the Louvre Accords in February 1987 to stop the decline of the US Dollar. The second volatility consequence happened when Australia’s government under Bob Hawke’s Australia Labor Party proposed in 1984 and implemented in 1985 to remove interest rate ceilings on loans and deposits as part of a larger financial deregulation of Australia’s finance and bank system introduced in the 1981 Campbell Report. Australia and AUD/USD suffered the effects as December 31,1984, AUD/USD opened at 0.8320, traded its lowest low December 31 1986 at 0.6308 and opened at 0.7105 December 31, 1987. AUD/GBP opened at 0.7125 March 31, 1985 and by December 31, 1987, opened at 0.4391. By the 1990’s, interventions would continue.

 

From 1991 – 1998, interventions progressively decreased from the 1991 high of 57 to the 1997 low of 2 and 12 in 1998.

 

Beginning in the 2000’s decade, 2000 saw 17 interventions while 2001 experienced 19. From 2001 to present day, the RBA intervened only as a result of the United States August 2008 Housing crisis. Then, the RBA intervened once in 2007 and nine times in October and November 2008. AUD/USD July 2007 experienced a market price of 0.9838 then saw a drop to 0.6021 by October 2008. Interventions since 2008 ended although three recent speeches by RBA head Stevens mentioned AUD/USD’s overvaluation and the July 2014 RBA Minutes revealed AUD/USD was not only overvalued based on “historical standards” but commodity prices were also low. The point regarding commodity prices is vitally important to understand AUD, its early free float and interventions.

 

A Commodity Currency

 

Along with the free float, a discussion originated in the 1984 -1985 Australian Parliament to understand AUD’s type of currency. An official Government report was released and revealed AUD moved in the markets based on its exports of Commodities. Then, Australia was exporting primary products of Wheat, Coal and Petroleum but importing less manufacturing products. The suggestion to smooth the exchange rate was import more manufacturing products. As time progressed, exports of commodities and various types grew exponentially to the point exports in the last 10 years comprise 55% of total exports and account for 11% of GDP.

 

From 1984 -1985 period is when work began to construct Australia’s Index of Commodity Prices but the overall discussions began as a result of the 11.07 billion Current Account deficit in 1984 – 1985 and 14.50 in 1985 – 1986. AUD then became known informally as a Commodity Currency and various commodities important to Australia began a close tracking of prices in relation to exchange rates because exports from free float beginnings were exported in either AUD, USD or Special Drawing Rights. Why the “informal” mention of AUD as a commodity currency is in its formal yet historic definition. A true commodity currency is money backed by gold as opposed to fiat money backed by the economy. While AUD was on the Gold Standard, it was truly a commodity currency but shifted to Fiat as the free float began.

 

Whether the RBA has an explicit intervention policy is unknown but the common theme throughout Australia’s years is interventions occur when Fundamentals are not aligned to the exchange rate. Part of the fundamentals concern commodity prices as much as balance of payments and other economic releases. A high exchange rate in light of low commodity prices is as much ground for intervention as much as an exchange rate misaligned to any economic release but the focus is primarily commodity prices. The historic assumption since the free float is a high exchange rate in AUD/USD occurs when Australia’s natural resources are demanded and a low exchange rate when commodity prices are low. Traditional RBA intervention practice is verbal warnings are issued directly to market participants then intervention follows.

 

A Commodity Currency

 

Along with the free float, a discussion originated in the 1984 -1985 Australian Parliament to understand AUD’s type of currency. An official Government report was released and revealed AUD moved in the markets based on its exports of Commodities. Then, Australia was exporting primary products of Wheat, Coal and Petroleum but importing less manufacturing products. The suggestion to smooth the exchange rate was import more manufacturing products. As time progressed, exports of commodities and various types grew exponentially to the point exports in the last 10 years comprise 55% of total exports and account for 11% of GDP.

 

From 1984 -1985 period is when work began to construct Australia’s Index of Commodity Prices but the overall discussions began as a result of the 11.07 billion Current Account deficit in 1984 – 1985 and 14.50 in 1985 – 1986. AUD then became known informally as a Commodity Currency and various commodities important to Australia began a close tracking of prices in relation to exchange rates because exports from free float beginnings were exported in either AUD, USD or Special Drawing Rights. Why the “informal” mention of AUD as a commodity currency is in its formal yet historic definition. A true commodity currency is money backed by gold as opposed to fiat money backed by the economy. While AUD was on the Gold Standard, it was truly a commodity currency but shifted to Fiat as the free float began.

 

Whether the RBA has an explicit intervention policy is unknown but the common theme throughout Australia’s years is interventions occur when Fundamentals are not aligned to the exchange rate. Part of the fundamentals concern commodity prices as much as balance of payments and other economic releases. A high exchange rate in light of low commodity prices is as much ground for intervention as much as an exchange rate misaligned to any economic release but the focus is primarily commodity prices. The historic assumption since the free float is a high exchange rate in AUD/USD occurs when Australia’s natural resources are demanded and a low exchange rate when commodity prices are low. Traditional RBA intervention practice is verbal warnings are issued directly to market participants then intervention follows.

 

AUD/USD Long Term Averages

 

If the December 1983 post float average at 0.7626 is considered, AUD/USD is not only not overvalued but the calculated target is 0.8928 and is well within the distribution between 1.1532 – 0.8503.

 

If averages from 1970 and 1971 at 0.8861 and 0.8802 are factored, AUD/USD is vastly oversold with targets at 1.1190 and 1.1125. Both average distributions lie within neutral zones between 0.8076 – 0.8645 and 0.8019 – 0.9584. The common theme among the three averages is bottoms are found at 0.8076, 0.8064 and 0.8019.

 

Between 25 and 20 year averages at 0.7643 and 0.7696, targets become 0.9226 and 0.9028 and neither average is oversold / overbought as prices trade middle range inside both distributions. Prices at 0.8109 and 0.8211 must break to see lower prices.

 

The 14 year average at 0.7990 targets 0.9680 and price lies inside a distribution between 0.9129 – 1.3060. The 10 year average at 0.8806 targets 0.9976 and price lies between the distribution at 0.9594 – 1.2315. A break of 0.9200 in the neutral zone reveals a new shorter term distribution would fall between 0.8806 -0.9200. The 5 year average at 0.9732 targets 0.9068 and prices are within a distribution between 0.9732 – 0.9284.

 

The common theme within a 5-55 year historic walk is all averages lie beneath present prices except the 5 year and all remaining averages are not threatened by breaks anytime soon. Further, all averages are either vastly oversold or approaching middle bounds between oversold and overbought. As the world regains its economic composure once again, AUD/USD has the potential to see far higher prices over time.

 

Monetary Policy

 

Australia’s Monetary Policy foundation began with passage of the 1911 Commonwealth Bank Act, a main bank in Australia today. The bank was established with 1 million Australian Pounds where bank profits were distributed between a Reserve and Redemption fund.

 

The RBA was born from early Commonwealth Bank beginnings and the relationship growth between Reserve and Redemption. Not until passage of the 1959 Commonwealth Bank and Reserve Bank Acts would the RBA receive official birth when the Commonwealth bank was split into the Commonwealth Banking Corporation and the RBA became a separate entity.

 

Issues regarding the Commonwealth Bank’s Reserve and Redemption Funds were seen in the 1920 Notes Act when issuance of Australia’s notes became the sole domain of the Commonwealth Bank from Australia’s Treasury Department’s origin as originator. A Note Issue Department was established and existed until 1924 when a Bank Board was created to issue Notes.

 

The Bank Board would exist to issue Notes for the next 35 years until the RBA would assume control in 1959 / 1960 under a formal Reserve Bank Board created by the Bank Act of 1959. The move would become the first formal powers toward an independent Central Bank despite calls dating to the 1920’s when questions arose regarding exchange rates, credit, size and scope of Notes issuance, budget amounts and Australia wasn’t on the Gold Standard then. Many problems existed in the early 1920’s but essentially the Commonwealth Bank was the Bank for the Australia Government from 1920 – 1960.

 

The 1945 Bank Act allowed Commonwealth Bank to pursue a monetary policy with goals to achieve currency stability, full employment and prosperity. Further, the 1945 Act allowed Commonwealth Bank to pursue a monetary policy “beyond Australia if necessary”. By passage of the 1951 Banking Act, monetary policy transferred to a board. The 1953 Bank Act not only affirmed rate of interest would remain the same but it was illegal for Gold to leave Australia. Monetary policy began due to the Reserve and Redemption funds however slow.

 

Monetary policy was again a slow and gradual process until 1976. The focus from the 1920’s – 1970’s regarded fixed exchange rates coupled with Fiscal policy. The 1930’s experienced depression and war, and GDP for example dropped 10% in 1931. The late 1930’s addressed questions of Macroeconomics in the Australian Parliament and resulted in a 1937 Royal Commission report. Over 200 economists testified regarding adoption of various macroeconomic policies prudent for Australia such as recommendations for Keynesian economic policies, high versus low taxes, free float versus fixed exchange rates, independent central bank, control interest rates, allowance of private sector growth vs government growth, regulation and non regulation of banks. Testimonies spanned a large spectrum of economic issues.

 

Budgets however were fluid over the years particularly during the early periods through various devaluations of GBP and its effects to Australia. The 1947  GBP devaluation was still seen in the 1950 Australian Parliament for example when the devaluation was prominent regarding Australia’s proposals to export wool and ability to obtain its proper price based on Australia’s exchange rate.

 

Fiscal policy and taxes in relation to fund government budgets became a mandatory tool particularly when Interest Rate Controls were placed on Australian Government Bonds. Monetary policy was first seen in the 1970’s when reform slowly began and for the RBA to obtain independence, it was first seen in removal of interest rate ceilings.

 

Interest Rates

Until September 1973 when interest rate ceilings were removed on Certificate of Deposits, interest rate controls were enforced on bank deposits, interest charged on loans and maturities on term deposits. By 1980, full interest rate ceilings and fixed deposits were removed but most important was banks entered the market fully to compete for overnight funds.

 

The overnight Cash Rate began trading in May 1976 with actual Cash Rate targets first seen in August 1990. Once removal of bank restrictions to raise funds less than 14 days was implemented in 1984, Australia’s interest rate markets were fully developing. For example, interest rate ceilings were removed on bank loans less than 100,000, interest was paid on large deposits held less than 14 days and small deposits less than 30 days. Term deposits increased longer than four years. Despite the transfer of power to set the overnight interest rate from the Bank Board to the RBA, responsibilities and independence would not implement fully due to the gradual process to trade Bank Bills.

 

Bank Bills are security investments ranging from 1 -180 days. Two forms exist, Bank Accepted Bills and Bank Endorsed Bills. A Bank Accepted Bill is a Bill of Exchange and accepted by banks where banks pay face value at maturity. A Bank Endorsed Bill is a Bill of Exchange endorsed by the bank. Simplistically, Bank Bills today are Bank Accepted Bills that comprise negotiable Certificates of Deposit that range from 30, 90 and 180 day terms and are by far the most important interest rates in Australia to understand the term structure of interest rate paths. The overnight rate is also vital but its a 1 day rate and assists in the daily view of interest rate paths.

 

Bank Bills are security investments ranging from 1 -180 days. Two forms exist, Bank Accepted Bills and Bank Endorsed Bills. A Bank Accepted Bill is a Bill of Exchange and accepted by banks where banks pay face value at maturity. A Bank Endorsed Bill is a Bill of Exchange endorsed by the bank. Simplistically, Bank Bills today are Bank Accepted Bills that comprise negotiable Certificates of Deposit that range from 30, 90 and 180 day terms and are by far the most important interest rates in Australia to understand the term structure of interest rate paths. The overnight rate is also vital but its a 1 day rate and assists in the daily view of interest rate paths.

 

When interest rate ceilings were removed, only the 90-day Bank Bill was available for trade and its trade data dates to 1969. The 30 and 180 day Bank Bills began to trade in July 1992 and the Cash Rate Target began trading August 1990. To understand Australia’s interest rate paths was only to view the Overnight Cash Rate and the 90-day Bank Bill. Viewed together, both contained wide variations.

 

Consistent with 1900’s Swedish economist Knut Wiksell and his Neutral Interest Rate viewed from 20 – 50 years to understand an economy’s economic context, Australia’s current 90-day Bank Bill rate is far below the Neutral interest rate. The 20-year average is found at 5.33, 25 year at 6.13, post 1983 free float at 7.67 and since 1969, 8.44. Targets range from 3.27 – 4.22 and price at 2.63 is approaching bottoms. If any wonder existed how AUD/USD would see far higher levels, it’s found in Bank Bills because Australia’s economy seen from interest rates is underperforming.

 

The point of reference is the RBA doesn’t disclose nor offers information regarding its Neutral Interest rate but not only does New Zealand employ the 90 day Bank Bill as its Neutral Interest Rate but its the rate suggested by Wiksell and employed by many nations today.

 

Monetary Policy and Inflation Targets

 

Australia’s Parliamentary authorities realized early in the 1970’s world economics as a whole was headed towards interdependence particularly under a free float exchange rate system where nations were most interested in protecting and properly aligning currency prices versus the next nation. Exchange rate markets journeyed full circle from the 1920’s volatility to fixed periods, Gold Standards and to outright destruction of another nation’s exchange rate.

 

Interdependence was an economic system where all nations would adopt the same policies as the next nation but accompanied with certain twists and tweaks in each nation. Economics in its own right also adopted a full circle approach from serious deflation in the 1930’s to exhorbitantly high inflation in the 1970’s. The 1930’s witnessed government controlled Keynesian policies while the 1970’s experienced monetarism to target and adjust money supplies. Australia was no different in this regard as they first adopted discretionary budgets.

 

Monetary Policy 1971 – 1985.

 

Monetary Policy from 1971 – 1976 was classified as discretionary budgets. If Real spending growth by CPI is a gauge, 1975 -1976 was the only negative cash balance year within the period.

 

From 1976 – 1985, Australia adopted a monetary policy titled Monetary Targets where the target was M3 money and set by the Treasury. In light of interdependence, the United States, Germany, England and Switzerland all adopted Monetary targets.

 

The goal was to reduce inflation but targets missed every year except 1981 so inflation rose, GDP dropped and large budget deficits were seen. Budget deficits would result in deficit spending to borrow monies by selling more bonds to cover the deficit gap. To borrow money while in deficit results in money printing and results in printing spirals as more and more bonds are sold with interest rate controls to cover increasing gaps. By 1985, M3 rose to 17.5%.

 

1993 – Present Inflation Targets

 

RBA head Ian Macfarlane’s 1998 speech highlights the next economic experiment termed Inflation Targets. New Zealand again took the lead in 1990 and led the world on the path to Inflation Targets followed by Canada in February 1991, the UK in 1992, Sweden, Finland and Australia in 1993.

 

The target is the “price path with the goal to maintain price stability by anchoring Inflation over time versus price changes”. The objective would become price Inflation or simply CPI, the Consumer Price Index. Why New Zealand is because New Zealand as a leading central bank was the first to revamp CPI indices so they adopted Inflation targets in line with newly revamped CPI Indices.

 

 

Australia defines and implements its Inflation Targets as an average rate of increase in CPI of 2% – 3% over a medium term. A medium term further defined in both Macfarlane and Stevens’ speeches is if Inflation has a 2 in front of it over time, Inflation is on track.

 

Real Spending Growth by CPI since 1993 experienced negative Cash Balances from 1993 to 1998 then positive from 1998 to 2001 and negative in 2002. From 2003 to 2008, cash balances were positive then began negative years between 2009 and 2014. Current CPI is 3% and at upper end of target.

 

Upon the formal adoption of Inflation Targets in 1996, the RBA was officially recognized as an independent central bank.

 

Since 1980, Australia as well as the United States experienced negative Current Accounts. Neither has been positive since 1980 and remained well below the all important 0 line. Over a longer horizon, Australia’s Current Account has been negative since 1959 and is now slowly approaching the 0 line.

 

Top four export nations in the last four years in order is China, Japan, South Korea and the United States. Top four import nations are China, United States, Japan and Singapore. Top five two way trade is found between China, Japan, United States, Korea and Singapore. Iron Ore is the number one export followed by Coal, Natural Gas and Gold. Iron Ore is employed to make Steel so its obvious exports head to growing nations to build buildings, tunnels and bridges. Only since 2010 has Australia’s trade shifted to Asian nations.

 

 

Australia 10 Year Yield

 

The most important Bond yield for Australia is the 10 year. The current 10 year average of the 10 year yield is 4.95 and its highest price seen in the last 10 years is 6.81 and lowest price was 2.68. Traditionally, as long as the 10 year Australia bond Yield is above the United States 10 year yield, AUD/USD is a long and short upon Australia yields below the United States. The current 10 year yield average for the United States 10 year bond yield is 2.72. The current Australia yield is 3.37 and 2.34 for the United States.

 

Budget Years

 

Australia’s Fiscal year begins July 1 – June 30. How and why budget years began in this time frame is unknown. The UK’s Fiscal year begins April 1 – March 31. One would note the many references to December throughout the text. December is almost the half-year point and a popular month historically to adjust interest rates.

 

FIX Price

 

A currency Fix price began under the early Gold Standards where a currency price was fixed by Government, bank or currency board to the Gold price. Generally the Spot rate was employed as the basis for any Fix price. Under free floating exchange rates, governments and central banks found creativity by fixing currency prices to Trade weight indices, another nation’s currency, a currency board, Trade weight baskets or free float but manage the price heavily as it trades. In Australia’s early years in the 1920’s free float, bank cartels in London negotiated the Fix price. Today, central banks employ and decide a Fix price daily based on Spot prices and usually in conjunction with its domestic banks. Australia releases its Fix price at 10:00 a.m. promptly Australia time.

 

AUD and Monetary Policy

 

The enemy of any central bank since 1970’s interdependence is the business or any cycle that deviates from economic projections. Inflation Targeting as a policy is here to stay for the foreseeable future because to control inflation controls GDP, employment and interest rates within small channels. It’s a top-down approach but one that has served central banks well since the high 1970’s inflationary periods.

 

If the yield curve is viewed as an inflation curve then Inflation Targeting has the effect to also control exchange rates within small ranges. As long as Inflation holds within projections, central banks can extend economic periods far into the future. They conquered what they sought to control since the industrial revolution and its not market friendly to volatility but it may ensure trends remain and more certain. But no policy last forever, its periodic.

 

A note on cycles. The United States 1982 Official Gold report reveals since the 1500’s, the gold versus paper currency standard reigns in each period about 50 years. Governments spend in excess and can’t repay paper currency debts so Gold periods reign. Once a need exists for governments to spend in excess of Gold to currency Fixes, paper currency floating becomes the order of the day. If 1971 is the beginning of floating exchange rates, 2014 marks the 43rd year.

 

Within 50 year periods derives market crashes such as the 1998 Russian Ruble crisis, 94 / 95 Mexican Peso and 1997 Thai Baht crisis. The 2008 United States housing collapse was a market crash.

 

Australia never causes nor will cause a crash rather they suffer the effects but they also are resiliently able to weather any storm. Australia’s dilemma is commodity cyclicality and negative balance of payments. Commodities cycle with economic growth and it is reflected in its balance of payments. Now that the RBA has true independence, they are capable of staying ahead of any curve.

 

AUD as a currency is equally resilient. Many view AUD as a cousin to NZD when, in fact, AUD is more a Euro than NZD. Its construction, trading ranges and possible deviations are more aligned to the Euro than NZD. As time progresses, AUD will be much more widely accepted as the currency that weathered every economic and currency storm over a 203 year period.

 

Despite quite a monetary, exchange rate and nationhood journey, Australia after 115 years since 1901 fought the hard fight and won.

 

Brian Twomey

G10 and NFP: Levels, Ranges, Targets

NFP forecasted at 98 Vs 156 for September is viewed as low and light for the calculation in terms of NFP averages. A rough support exists at 92 and 81.20 but both points to hit assumes 106 fails to break higher as well as targets at 118 to 122. The 98 point is below every average from 1 to 78 year monthly averages. The nearest significant break above is located at 174.50. Above targets today include 118.46, 119.30 and 122.43. The next target is found at 103.50. The overall range trade will see NFP from 58 to 148. Above or below will see prices in range breakouts. NFP averages month to month are volatile which means certain months are forecasted perfectly while others requires a bit of work.

Interesting timing for NFP today as many currency pairs are on the verge of significant breaks.

EUR/USD and USD/CAD hold the most significance because as opposite pairs, both contain widest ranges. Why EUR/USD and CAD is because USD/CHF contains supports at 0.9642 and 0.9716 Vs next above at 0.9849.

EUR/USD. Break points for EUR are located at 1.1676 and 1.1646. A break lower at 1.1676 and 1.1646, targets 1.1426 and 1.1405. EUR/USD to hold above 1.1676 and 1.1646, targets 1.1884 and 1.1926. This is the medium to shortest term view.
Today’s break points above are located at 1.1730 and 1.1787. We’re not looking for 1.1787 to break unless NFP reports far out of kilter. Below break points are 1.1658 then 1.1649, 1.1646 and 1.1636.

USD/CAD faces massive resistance above at 1.2620 and 1.2629. A significant bottom for today exists at 1.2526.

GBP/USD. Mentioned many times is dangerously low UK interest rates. Dangerously low means near zero then negative. The BOE maybe forced to raise only because of dangerously low interest rate levels. Dangerously low means current rates lifetime lows and nevr seen. Lifetime lows means since 1963 for Repos and 1997 for Sonia.

QE for the BOE isn’t the greatest factor overall as the amounts are about 400 million.

GBP/USD lies inside vital break points at 1.3050 to 1.3107. For today’s trade, supports exists at 1.3052 and 1.3030 Vs above at 1.3107, 1.3130, and 1.3163.

NZD/USD is most interesting for today as its current price is massively oversold. Today’s shorts are not recommended. The nearest break points overall are located at 0.7210 and 0.7291. Oversold means averages from 5 to 100 day. Most significant point today is 0.7151 and we view as holding far below.

EUR/JPY sits om supports at 131.50 and 130.12. The longer view for EUR/JPY and written many times over past months is EUR/JPY trades above EUR/USD and USD/JPY on a 5 and 6 month view as well as 1 year. USD/JPY must rise or EUR/JPY must fall further to rectify this situation.

Brian Twomey

NFP Preview and Forecast: Oct 2017

NFP last in September at 156 is forecasted at 98 for October and this forecast derives from the 9 year NFP monthly average. NFP in August hit the 5 year average at 202 and fell significantly to 156. The number to beat for August was 206 then 206 would’ve been above every average from 1 to 78 years. Above 206 appeared as a bright future for continued job gains over coming months. What is 78 years is the February 1939 start of NFP.

The 98 forecast figure is to low in terms of the averages. From previous 156, it also falls outside the crucial 50,000 range average as 50,000 is the traditional range average since 1939 inception. The downside should be viewed from 106, 156 minus 50,000. Further, downside targets to NFP are located from 118.46 to the high side at 137.07. Below 118.46 then next comes 103.50 and 81.20 at the 9 year monthly average. Factor average targets to 103.50 and 81.20 offers 92’s and not the 98 forecasted. Its not uncommon to see the BLS wrong in forecasts as they render the same mistake as the crowd by forecasting NFP in short terms.

Further to 50,000 is its the breakout point to market prices. The topside must see 148 or above to see for example EUR/USD experience a 100 pip day but this break point factors against any market price. A break of 50,000 NFP means a range break in market prices. Within 50,000 then prices range trade as the strategy becomes buy low and sell high.

The figure 156 and 98 forecasted is below every average and every median within every average from 1 to 78 years. The bright future from monthly averages fails the promising job gain views for this month. NFP averages are volatile month to month so what appears as dreadful this month may appear again bright next month. Here;s examples from August writings.

The 1 year monthly average in May 2015 was 208.83, climbed to 243.25 in September 2015 then dropped to 186.50. The 5 year average in May 2015 was negative 498.88, jumped to 199.10 in September 2015 and now sits at 206.38. The 2 year average was 191.37 in May 2015, bolted to 233.87 in September 2015 then dropped to current 194.25. The 10 year average in May 2015 was 66.19 and now resides at 69.34. The 25 year average in September 2015 was 108.50 and is now located at 125.35.

The highest average and number to beat is 232.64 at the 9 year average. Again, the 9 year average plays the most crucial role for this month. Normally forecast are seen fron monthly averages 1 to 6 years. Massive resistance points exist above starting from 174.75, 176.50, 187.50, 189.50, 190, 192 and 197. As a tough slog exits for NFP to travel higher, I view this month as within the 50,000 range and market prices range trade.

The point of note is 174.75 is the first resistance point and a long way from 98. My forecast from the downside is 118.46 to 122.43. Above I’m looking at just under 148. And overall, I don’t see the range break trade.

A primer on the 50,000 and NFP history.

The NFP driver and now more than ever in the 78 year history of NFP’s is the time to focus on the 50,000 because 50,000 is the currency market price break point. The 50,000 is seen more times in the last 3, 10 and 20 year monthly averages than any other time in NFP’s history.

The 50,000 was seen 85 times in the last 20 years, 71 times in the prior 20 years, 68 times in the prior 20 years and 37 times from February 1939 to 1952. Overall, the 50,000 was seen 261 times in 942 months or 1/4 over the life of NFP. .

Was the 2008 and 2009 period the worst NFP’s seen since the Great Depression. No because the release began in February 1939 and long past the Great Recession.

220 months or 18.3 years from a total of 941 months or 78.4 years were negative. This means 721 months or 60 years were positive job growth numbers. 2008 to 2009 or 23 of 24 months were negative.

The next negative period was the 2001 terrorist attacks on the World Trade Center. Then the 1980 – 1981 recession followed by the Kennedy Assassination in 1960 to 1961.

Further negative years include 1974 to 1975 and 1956 to 1958. Next comes 1952 to 1954 and 1944 to 1949. This period 1944 to 1949 was WW 2 as well as Bretton Woods.

Charted, 1944 to 1949 was the worst period in NFP’s 78 year history due to a speculation of a smaller population and overall smaller number of persons in the workforce. Read WW2 history to realize, the US was ill prepared to fight a war. The US didn’t even have guns to match the Germans.

Brian Twomey

Reserve Ratios and Excess Reserves Interest

 

As month end approaches and monthly positions adjust, central bankers first priority is check money supplies as they are constrained by not month end but the 35 day Maintenance Period instituted by the United States in 1979. The 35 day Maintenance Period then carried over in 2000 to a central bank meeting every 35 days. Forward Guidance as next priority allowed the central banks to inform all is fine and the news conference validates the various economic scenarios. As money supplies are released at month end for the previous month, central banks are governed by trader month end to the 35 day period.

 

Prior to the build in stimulus and money supply concentrations by central banks, overnight rates free floated as market determinations rather than the new tool to hold overnight rates in tiny ranges. A bank in deficit at end of day had to buy currency to balance while a surplus bank sold currency. The overall supply of bank money at day’s end determined if the overnight rate reported higher or lower and in turn affected other market interest rates. Interest rates and money supplies back then as today held an adverse relationship. By week’s end, the central bank then added or subtracted monies to maintain a balanced money system.

 

Under stimulus, the system shifted as the overnight rate was controlled by volume weighted medians rather allow a free float and this allowed the central banks to multiply and have their way with stimulus. The overnight rate was separated from stimulus. If the main overnight interest rate is controlled then all interest rates associated with the overnight rate is controlled as one interest rate affects another. The methodology is hold interest rates in tiny corridors so to never allow the system to crash or spiral out of control while stimulus is employed to purchase bonds.

Fed funds closed at 1.16 in 37 of the past 38 days and 79 of the past 81 days since June 2017. What explains the 2 lost days is Fed Funds traditionally takes a dive 1 or 2 days every month and closes lower, 1.06 and 1.07 since June.

Europe’s Eonia in the same time frame traded 0.63 to 0.65. USD money supply at M2 in June 2017 was 13, 548.9 billion and sits in September at 13,694.2 billion, a 145 billion rise in 3 months. European M3 went from June at 11,650 billion to August at 11,743, a 93 billion rise. Despite the money supply moves, interest rates remained stasis. If actual balance sheets were factored and interest rates properly adjusted then current overnight rates would be located at far lower rates.

If 1.16% is factored to 13,694.2 then M2 should be 15,885.2 to minus 15,885.2 and Europe’s M3 should be 7632.95.
The money supply/ interest rate relationship experienced money velocity to dive on a straight line trend downward as the relationship is out of kilter. USD M2 money velocity in Q2 2008 went from a high at 1.92 to 1.73 in Q1 2009 to current 1.42. European M3 growth rates on a seasonally adjusted basis flat lined since 2014 when the ECB went negative.

If velocity dives it means GDP is out of sync to M2 as velocity answers how often does the currency in use purchase goods within a time period. Velocity should travel higher when an economy is on a growth track but this is seen when money supplies decrease. Europe’s economy recovery is inside a 50 – 50 shot.

Velocity validates the progression money supply, interest rates, exchange rates, other financial instruments then price indicators in GDP and Inflation. If money supplies rise then interest and exchange rates drop as well as GDP and Inflation. What is solidified is the overall market indicator price relationships. GDP in the United States for the past 8 years is reported by the Office of Management and Budget as an average at 1.9%. GDP grew 2.1 trillion from 14.4 trillion to 16.5 but debt and money grew far faster.

The easy aspect to money supplies as an indicator are overbought/ oversold issues while far more in depth issues exist to Capital Ratios, supply to steer money to loans, Repo and interest rate markets and questions to paying interest on excess reserves and Reserve Ratios.

Market interest rates free floated before stimulus because Reserve Ratios targeted the short term weekly demand by supply of money in M1. Money imbalances to reserves caused a move in Fed funds and this is the Open Market operations aspect to Fed Policy. By today’s control of money supply to meet predictive reserve demand, Reserve Ratios were employed to stabilize money markets and interest rates to prevent fluctuations.

Current January 2017 Reserve Ratios in Net Transaction account liabilities are running 10% and 3%. The 10% and 3% has been fairly standard since the Garn St Germain act in 1982 although the 1990’s experienced a drop from 3% under Willie Clinton. Drop the low end from 3% to 0 then spurs more loan growth as money becomes available and not subject to the penalty tax of reserves ratios.
0 to $15.5 million = 0 requirement
$15.5 million to $115.1 million = 3%. Current threshold amounts and channel is $15.5 to $115.1 million.

 

Above $115.1 million = 10%. Current threshold amounts and channel is $15.5 to $115.1 million due to the lower 3% liability. The questions to 10% and 3% are amounts to the low side of 3%. The current 0 to $15.5 million is the result of Garn St Germain as the first $2 million was exempted from liability consideration. The adjustment amount exempted as reported by the Fed is factored “upwards as 80% of the previous years rate of increase in total reserve liabilities”. If no increase then no adjustment to exemptions as was seen from Dec 1988 to Dec 1990 and Dec 2009 to Dec 2010.

In January 2009, the low sides were $10.3 million exempted to $44.4. In January 1984 at the start of Garn St Germain, the low sides were $2.2 million exempted to $28.9 million. Since 1983 the low side experienced a continuous rise in money amounts as well as exemptions. Overall, current Reserve Ratios are 0 to 10%.

 

From 1984’s lows at $28.9 million, it took 27 years to Dec 2010 to see $58.8 million and 2 times the amount from $28.9. The exemption from $2.2 doubled to $4.4 in 1996 and in 12 years time. Then $4.4 million doubled to $8.8 million in 2006 to 2007 and 10 years time. Since the $8.8 million in 2006 to 2007 and at the current $15.5 exemption, its been 10 to 11 years and the next double comes at $17.6 million. From Fed Funds at 1.16 and factored to $15.5 and $115.1 then the range results to $17.98 million to $133.51.

From 2009, at $44.4 to $10.3 to current $115.1 and $15.5, the $44.4 doubled in 8 years while the exemption rose $5.2 million. In the previous 10 years from 2009 to 1999, the low end ranged from $42.1 to 48.3 while the exemption went from $5 million to $7.8 million. The current period from 2009 to present is the most volatile since 1982 beginnings of Garn St Germain.
As the Reserve Ratio traditionally was viewed as a tax because required reserves failed to earn interest as money sat idle and because Reserve Ratios never moved for or against interest rates, the current 1.25% payed on excess reserves became the premiere indicator since 2008 as it moves alongside a rise or fall in headline interest rates. Excess reserve interest became the money and overall interest rate channel and replaced the reserve ratio as the new monetary policy.

 

Since 2008, interest paid on excess reserves acted as a floor and ceiling alongside the effective fed funds rate. Current Fed Funds at 1.25 means the floor and ceiling channel flows from 1.0 to 1.25. At 1.25 represents the ceiling while 1.0 acts as the floor and the target range is a standard 25 points. At 1% interest rates, the channel became 0.75 to 1.0.

When interest rates were near 0, the channel was set by the Fed at 10 and 15 points so not to allow a 0 interest rate. Call it a channel or corridor but 25 points is where is seen repos, reverse repos, fed funds trade activity as well as bank money to satisfy reserve requirements. The Feds complete domination of interest rates sets the channel at any rate to their desire.

Since 2008, excess reserves skyrocketed on a straight up trendline. From an economic view, the effects to skyrocket reserves on lending, economic activity and bank loans appears as no effects. Inflation rates since 2008 appear immune from high excess reserves. The money multiplier appears immune as well. Money available to lend by banks doesn’t mean anyone wants a loan. If the Fed again raises then interest on excess reserves will again rise to a higher degree of excess money.

 

If the interest paid on reserve channel is expanded, much volatility will come to interest rates and all market prices. To maintain or restrict the channel then excess reserves will continue expansion . As long as interest is paid on reserves, excess money will expand.

The concomitant example is Willie Clinton lowered the 3% Reserve Ratio to zero and Fed Funds as well as all interest rates and market prices saw huge volatility. As the 3% threshold was reestablished then markets and interest rates normalized to an acceptable range.

Interest paid on excess reserves is an experiment yet long advocated by the fed dating to Arthur Burns as Chairman of Eisenhower’s Council of Economic Advisors and Fed Chair from 1970 to 1978.

The Fed views the excess reserve channel not from a monthly perspective but from the 35 day maintenance period.
 

Brian Twomey