Currency trend is not our friend

Only one thing is certain about floating exchange rates, they float...up and down.

A currency's direction would be easier to predict if, and only if, it does not stir up reactions in the macro-economy and central bank policy responses.

Take for example the Reserve Bank of Australia's latest missive: "The Australian dollar has appreciated over recent months, partly reflecting a lower US dollar. The higher exchange rate is expected to contribute to the subdued price pressures in the economy. It is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast."

This followed August's 'Statement on Monetary Policy' where the RBA noted that: "It is possible that the Australian dollar could appreciate further, which if sustained, would be expected to result in a slower pick-up in economic activity and inflation than currently forecast. Based on historical relationships, a 10% appreciation of the trade-weighted exchange rate (that is not associated with higher commodity prices) would be expected to lower year-ended inflation by a little less than half a percentage point over each of the following two years or so. Output would be expect [sic] to be lower by half to 1% in around two years' time."

And you betcha the Australian dollar surged - up by 11.4% versus the US dollar this year to date and 5.2% on the trade weighted index. And it is "not associated with higher commodity prices". The S&P GSCI commodity price index is down 2.8% this year to date. So are Australia's major commodity exports - coal prices are lower by 11.1% and iron ore is 7.3%.

The Australian dollar reached a high of US$0.811 during last week's trading before closing at US$0.806.

And sure enough, just as a falling Australian dollar brings out forecasts of more drops to come - remember the bearish $A outlook that did the financial media circuit about three to four months ago underscored by the headline, 'The Australian Dollar's Outlook Darkens' and predicting a depreciation to US$0.70 - out comes "extrapolations" of a  higher $A/US exchange rate this time.

According to the Australian Financial Review, "Analysts at Commonwealth Bank recently suggested that a continued slide in the greenback could see the Aussie dollar push as high as US85c by the end of next year."

Maybe the CBA is right. It's rationale for continued gains in the Australian dollar rational - synchronised global growth that would boost commodity prices and "a narrowing Australian current account deficit, and an improving Australian economy."

Not to mention, easing expectations over the pace of the US Federal Reserve's policy normalisation which as a result, caused an improvement in the Australia-US differential.

To be sure, the rationales put forward for the $A's fall (just a short while back) were equally rational.

But a persistent appreciation in the Australian dollar would, in time, reverse the "narrowing in Australian current account deficit" as Australian exports become less competitive and imports become cheaper. This would hit overall growth and reverse the improvement in the Australian economy.

The opposite of the bump up in economic growth and inflation the recent US dollar depreciation will have on America.

The point is that there's no point extrapolating the direction of the currency. This is because a currency's appreciation or depreciation sets in train certain dynamics that would return fundamentals to equilibrium.

Read more: Australian DollarAmericaAustralian Financial ReviewCBACommonwealth BankMonetary PolicyReserve Bank of AustraliaUS Federal Reserve
Link to something VR2aLuJz