At its December meeting the Reserve Bank Board decided to maintain the policy settings it adopted at the November Board meeting. The Governor reaffirmed that “the Board is not expecting to increase the cash rate for at least three years”. Over the course of the next few months, as we move to the next Board meeting on February 2, the Board may need to significantly revise its forecasts. Westpac has revised up its growth forecasts for 2020 and 2021 from –3% and 2.8% to –2% and 4% respectively. We expect the RBA will make similar adjustments which are also likely to see its unemployment forecasts move towards Westpac’s of 6% by end 2021 and 5.2% in 2022. That would see the unemployment rate close to the pre–pandemic level of around 5%.
Faster than forecast falls in the unemployment rate in 2021 and 2022 would certainly invite speculation in the market about the RBA’s policy direction. The decision to peg the 3 year bond rate target at the cash rate is the strongest form of forward guidance – much bolder than we see from other central banks that engage in forward guidance.
On the face value of the RBA’s current forecasts, Westpac’s view that the RBA will be required to adjust the target rate on the 3 year bond around mid 2022, seems reasonable but, as discussed, the risks around the forecasts will see significant market speculation around this issue through 2021.
We also learned from Deputy Governor Debelle’s speech last week that the 3 year rate is more significant for the private sector than the longer maturities (say 5–10 years). This implies that the sequence of any unwinding of the policy package from the November Board meeting is likely to be: QE first; followed by yield curve control; followed by adjusting the cash rate.
In the near term the Governor’s confirmation that “the Board will keep the bond purchase program under review, particularly in light of the evolving outlook for jobs and inflation … is prepared to do more if necessary” raises the real prospect that the $100bn program, which is targeted to be completed by June, will be extended. If yield curve control is not adjusted until mid–2022 there is scope for the RBA to extend its QE program in the second half of 2020.
For 2021, yield curves will steepen as global bond rates respond to the global recovery while central banks anchor short rates.
Since the Board announced its suite of policies on November 3 the AUD has risen from USD0.716 to USD0.75, hitting our long held year–end target right on time. As noted in the Governor’s decision statement the policy response contributes to “a lower exchange rate than otherwise.” Reasonably, the Governor attributes the depreciation of the US dollar and appreciation of the Australian dollar to a vaccine–related “improvement in risk sentiment”.
The steady rise in the AUD since mid–year, when it was trading around USD0.68 has been due to rising iron ore prices (up from around US$80/t to US$145/t); ongoing momentum in China as the government seeks to restore positive growth for the year;
Australia’s success in containing the virus; a boost to global optimism with the advent of successful vaccines; and positive surprises around Australia’s recovery and lift in consumer and business confidence since the recession.
There is understandable uncertainty about iron ore prices but the other factors seem set to roll into 2021 supporting our long– held USD0.80 target for AUD by end 2021.
Nearly all cycles in the AUD are long (2–4 years) and are generally linked to global growth and China’s growth and policy cycle in particular.
So 2021 seems a safe bet. The question is whether this momentum can extend into 2022. With the AUD having bottomed out in March 2020, a ‘normal’ two year plus cycle sees the upswing lasting well into 2022. Policy tightening in China and the developed world seems an unlikely prospect through most of 2022 so we can comfortably rule out an abrupt downward adjustment to the AUD.
For now, we are comfortable to project the upward momentum in AUD into 2022 reaching a high of USD0.82 before flattening off in the second half although there are clear upside risks to this scenario.
Fair enough. My base case of relatively short and sharp appreciation has obviously faded as iron ore has responded to the Chinese trade war on Australia.
That said, I still expect iron ore top in H1, 2021, unless China proves to be really stupid, which it has been so far.
So, onwards and upwards for now on a watching brief.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
