Chief economist update: Australia needs a cheaper A$

If it were posted on Facebook, Wall Street would have "unliked" the strong US non-farm payrolls report for June - up a bigger-than-expected 224,000 from 72,000 in May. Meanwhile, the unemployment rate ticked up to 3.7% from 3.6% in May, remains near 49-year lows and was due to the increase in the participation rate, itself a positive indication of the US labour market.

Sure, it was great news for the US economy but ... it also eased growing expectations the Fed would cut interest rates by 50 bps from the current 2.25%-2.5% as early as its July FOMC meeting to just a 25bps reduction.

The Reserve Bank of Australia (RBA) would have clicked "like" though. This is because rising Fed rate cut expectations have nullified its back-to-back 25 bps reduction (June and July) in the official cash rate to a record low 1%.

Consequently, instead of depreciating, the A$/US exchange rate strengthened from US$0.6928 (a day before the June rate cut) to as high as US$0.7018 on the last trading day of June. Similarly, the A$ strengthened to US$0.7032 a day after the July rate cut announcement (from US$0.6967 one day before the announcement).

'Twas only after the strong US employment report (that reduced Fed expectations for a 50 bps cut in July) that sent the A$ back down to US$0.6971.

This has also reduced pressure on the Australian central bank to cut the official cash rate down to zero - as some "extremists" foresee.

A floating currency is, after all, designed to restore equilibrium in the economy.

Case in point. The A$ absorbed some of the negative shocks from the Asian currency crisis - followed by the collapse of hedge fund Long-Term Capital Management (LTCM) and Russian debt default in the late 1990s when it dropped from more than US$0.80 to below US$0.60. It deflected the fallout from the 2001 US recession and September 11 by depreciating from US$0.65 to below US$0.50.

It cushioned the domestic economy during the global financial crisis (GFC) and the "Great Recession" when it dropped from US$0.9786 on 15 July 2008 to US$0.6036 on 27 October 2008 when the global financial system was in chaos.

Domestic manufacturing, retailing, tourism, education, to name a few, would be clicking on the "heart button" on Facebook. They'll also like the extra boost from their US dollar earnings when translated back into Australian dollars. A-hiring they will go and perhaps, offer higher wages too.

Wait there's more! Australian import-competing industries would also get a bump up as imported goods and services become more expensive in A$ terms, encouraging Aussies to buy "Made in Australia".

However, global economic dynamics suggest that the Australian dollar would need to be even cheaper in order to counteract the deceleration in global growth. More so, given the slowing Chinese economy - our biggest export client - and the downward pressure exerted on it by Beijing's on-going trade war with Washington.

Much will depend on the Fed - and its bias/action on the fed funds rate. The RBA would have to at least match the Fed's interest rate cut decisions to keep the A$ from appreciating.

More so because it remains unclear whether lower domestic borrowing costs alone is sufficient to prod Australians, all, ramp up consumer spending - particularly with local banks and lending institutions passing forward only a fraction of the RBA's recent rate reductions.

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