It was a wild trading session in the US overnight. That’s what you get in times of heightened ‘uncertainty’. Oil, which is clearly now in the hands of speculators, started the session down, falling below US$30 a barrel again. But then it turned, and soared, finishing up nearly 10% from the low point.
The Dow Jones index was dazed and confused too. Like oil, it fell at the open. By mid-morning it was down 250 points. It then turned up along with the oil price, sold off again, and finally soared higher as New York Fed President Bill Dudley had some soothing words for markets.
This is what he said to set off the afternoon rally:
‘One thing I think we can say with more confidence is that financial conditions are considerably tighter than they were at the time of the December meeting. So if those financial conditions were to remain in place by the time we get to the March meeting we would have to take that into consideration in terms of that monetary policy decision.’
The interesting thing about this is that the market wasn’t really pricing in much in the way of more Fed hikes anyway. But I guess it just feels better when you hear it from the horses’ mouth.
While the Dow finished up a handy 1.1%, the big moves were in foreign exchange markets. Dudley’s comments sent the US dollar sinking against nearly everything. The Japanese yen surged, which will confound the lunatics at the Bank of Japan. They just made rates negative…the yen was supposed to fall!
Gold and commodities surged, as did the Aussie dollar. It’s now back above 71.5 US cents.
That’s not what Australia needs right now. A weaker currency is one of the few things working in the economy’s favour.
The Aussie dollar rally comes less than a day after the Australian Bureau of Statistics reported horrendous trade data for December. The trade deficit came in at $3.5 billion for the month, a big deterioration on November’s deficit of $2.7 billion.
For the December quarter, the trade deficit was a massive $9.5 billion. That means Australia consumed $9.5 billion of goods and services more than it produced.
It also means the current account deficit (CAD) for the December quarter is going to be a big one. The CAD is the trade deficit plus interest payments on our net debt of roughly $1 trillion.
These large deficits need to be met with an inflow of capital (usually in the form of borrowing) to fund them. When less capital comes in than is needed, the exchange rate falls to provide the adjustment.
Countries with large trade and current accounts deficits usually suffer from a weaker currency. That’s because the deficits reflect structural issues in an economy. Foreign investors become wary of investing, and so the exchange rate falls to provide foreigners with greater purchasing power, or more bang for their buck.
A falling currency is an enticement for foreign capital to keep flowing. But at some point the falls become too much and capital flees.
Of course, Australia is nowhere near that point. Despite our large deficits, foreign capital is happy to keep coming in and financing our standard of living.
The Reserve Bank of Australia is clearly happy with this arrangement. The flip side of big deficits is debt growth and household spending. That’s exactly what the economy needs (apparently) as it tries to move away from and forget the debacle that was/is the mining boom.
Here’s the RBA’s head in the clouds view of the Aussie economy, made in its Tuesday statement to keep interest rates on hold.
‘In Australia, the available information suggests that the expansion in the non-mining parts of the economy strengthened during 2015 even as the contraction in spending in mining investment continued. Surveys of business conditions moved to above average levels, employment growth picked up and the unemployment rate declined in the second half of the year, even though measured GDP growth was below average. The pace of lending to businesses also picked up.’
The worrying thing is not what the RBA sees, but what it doesn’t see.
That is, the mining boom, which is well and truly bust, was the product of an unsustainable China credit bubble. In response, the RBA slashed interest rates and generated an unsustainable housing boom, to create enough spending to offset the fallout from the deflating commodities bubble.
So while the fallout from one unsustainable boom is right in front of our face, the RBA hopes the result of another unsustainable boom might be different.
But hey, who said long term foresight was a strong point of the nations’ leaders and bureaucrats? These men (and it’s nearly always men) can only see to the next election or the end of their term.
And RBA boss Glenn Stevens is out of here by the end of the year, so don’t expect anything other than legacy preservation from him. You’ll have to wait until he’s retired and working the lucrative speech/conference circuit to get any truth bombs…and even then you might be disappointed. Glenn seems like a pretty tight-lipped fella.
Meanwhile, Australia goes deeper in to debt to keep up appearances, to maintain economic growth and ‘transition’ from the mining boom. And to pay interest on that debt we borrow ever more.
What could possibly go wrong!
More on that tomorrow…
For The Daily Reckoning