The sharp drop in the Australian dollar has caught many businesses by surprise, especially those that either do not keep a close eye on the currency markets and/or those that may have been somewhat complacent that a high Aussie was here to stay.
For importers, a lower Aussie dollar increases the cost of goods or services bought from overseas and paid for in a foreign currency. And although domestic factors have changed little, much has changed overseas, particularly in the US which is a critical factor for our exchange rate.
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Unwinding the ‘Bernanke Put’
For the last few years the “easy” trade for many has been to hitch a ride on the back of the US Federal Reserve Bank chairman Ben Bernanke’s Quantitative Easing (aka printing money) policy.
This permeated across most asset classes ranging from bonds to equities and, of course, currencies. This gave rise to the phrase “the Bernanke Put” due to the fact the term ‘put’, applicable to options products, means a guaranteed sell price. The greenback traded lower against most currencies and with the Australian economy growing strongly at the same time, the Aussie dollar rose sharply benefiting Australian importers.
Around a month ago markets began to sniff the end of this trend with confirmation finally coming from the man himself. On June 19, following the Fed’s meeting, Bernanke gave global financial markets what they wanted – some clear direction. The following words set the world abuzz once again, triggering unwinding of the Bernanke Put:
“The committee currently anticipates that it would be appropriate to moderate the pace of purchases later this year… we will continue to reduce the pace of purchases in measured steps through the first half of next year ending purchases around mid-year.”
This is what the market heard. The chairman did not specify by how much they will “moderate the pace of purchases”, currently at $US85 per month, but instead focused on a timeframe.
Mr Bernanke preferred to use the wording “later this year” and “around mid-year” 2014, which was enough for the market to draw some definitive expectations. And with markets being as quick as they are to price in future expectations it is no wonder the US dollar has rallied hard against the Aussie dollar.
Is there an if?
There were of course some other comments from the Fed chairman that the market seemingly overlooked as less important. In fact, it is the dots that connect the two phrases above that hold some real significance. The following phrase was sandwiched in between, which – when read as one – gives a slightly different, but important tone to current market expectations.
“…if the subsequent data remain broadly aligned with our current expectations for the economy”
So there is an if – if future data supports their view. The very nature of forecasts, however, means they are continually adjusted both higher and lower. So there is a chance the Fed may have incorrectly forecast the future, which would mean QE policy remains for longer than expected. There does seem like a small risk of this happening at this stage but let’s remember this is QE3: i.e. the third quantitative easing program since the onset of the GFC, so anything is possible.
The Fed, and the world for that matter, will be watching developments on US economic indicators even more closely now. In particular US employment and inflation will be under the microscope.
Assuming these data points hold up well then we expect the first reduction in the QE program to come around September or October. Of particular interest will be the unemployment rate and whether or not it continues to push lower towards 7% and not higher from the current 7.6%.
Jim Vrondas is chief currency and payment strategist, Asia-Pacific, at OzForex, Australia’s leading international payments solution provider.