The RBA is finally getting what it wanted. The Australian dollar is starting to trend downwards. Overnight, the AU dollar dropped to $77.29 against the US dollar. That’s the lowest the exchange rate has been since late April, when the AU dollar rose above $0.80.
But the RBA shouldn’t be reaching for the champagne just yet. The latest drop only pegs it back to what it was last month before the RBA’s interest rate cut announcement.
The RBA couldn’t drive the dollar down by itself. Their 0.25% rate cut in April failed to spur the market. The promise of cheaper credit for borrowers didn’t materialise in a falling dollar.
Instead, they’ve been waiting for some kind of good news from the US to do their job for them. The US dollar’s status as the reserve currency in world trade means that any change to its value affects the AU dollar up or down. If the US dollar goes up, the AU dollar falls — and vice versa.
The reason the US dollar rose was because of better than expected economic data. Consumer confidence increased to 95.43, up from 94.3 in April. That uptick in confidence seems to stem largely from a 6.8% rise in new home sales. That’s a positive development in isolation. But the rest of economy looks less impressive by comparison.
Core capital goods — business related goods like machinery — orders rose by 1%. That was 0.7% better off than expected. But consumer goods, such as cars and appliances, dropped slightly this month.
But for the Aussie dollar to keep declining, US economic data will need consecutive months of good news. And that’s not something we can rely on. Let me explain why.
Why the US recovery may only be temporary…and what it means for interest rates
Economic data is cyclical. There isn’t a month that goes by that the outlook for the US economy doesn’t fluctuate. In March, US retail spending was down, easing pressure on the Fed to raise interest rates. But in April the US economy added 223,000 jobs, raising the prospect rate hikes.
Now that home sales rose in May, we have another feel good story. But there are many factors that could throw the US economy off balance in the next few months. Take oil for instance.
What would happen in June if oil prices continued to rise? Would consumer confidence remain as high? Not likely. Remember, the positive US economic data in the last few months has come on the back of US$50 a barrel oil. Now oil is starting to creep back up, hitting almost US$70 a barrel this month.
Any further rise in oil prices would dampen US economic data in the short term. Why is that important? Because it would raise concerns over the prospect for interest rate rises. And the Fed won’t raise rates unless the US economy proves it’s growing over an extended period of time. Without an increase to the US cash rate, the Aussie dollar will find it hard to slip much lower than its current position.
So the question for the Aussie dollar is the same one the rest of the world wants to know too. When is the US Fed going to raise interest rates? The answer is that it’s impossible to tell at this point. As long as economic data keeps fluctuating, it’s difficult to predict the Fed’s moves. But it seems unlikely that it will happen before 2016.
The reasons the RBA wants to devalue the Aussie dollar
There are a couple of reasons why the RBA wants to devalue the dollar. For one, it boosts exporter competitiveness, as demand for cheaper Aussie goods increases overseas.
The other benefit is that holidaymakers find Australia a cheaper place to visit. That’s important because the government has identified tourism as a growth industry. They want it to see its share of the economy increase, as the mining boom dies down.
The RBA know that Australia’s economic future will depend on low interest rates and cheap credit. But it may not be enough to keep Australia from entering its first recession in 23 years.
The Daily Reckoning’s Greg Canavan doesn’t believe anything the RBA does will be enough to prevent a recession. And he thinks it’s coming in 2015.
Greg is one of Australia’s leading investment analysts. He’s written for the The Australian and Sydney Morning Herald. And he’s made regular appearances on CNBC and Sky Business.
In his free report, ‘Australian Recession 2015: Unavoidable’ Greg reveals why the RBA realises economic hardship faces all of us. He’ll show you why government debt has ballooned to a crushing AU$300 billion — and why this means a recession is inevitable. Download your copy today and he’ll show you how you can protect your wealth from the imminent fallout. To find out how to download his free report right now, click here.
Contributor, The Daily Reckoning