Is the Reserve Bank close to stepping into the currency market to support the Australian dollar and, if so, what does this mean for millions of Australians?
While it’s a rare event, it’s been done before, and could happen again soon.
The Australian dollar has come under a lot of pressure over the past two weeks.
It’s lost ground to both the US dollar, or greenback, and the British pound.
In late September, the “Aussie”, as it’s known, hit 69.4 US cents.
On New Year’s Day (Australian time) it fell to 61.82 US cents.
It’s roughly an 11 per cent drop over the space of a few months, which is noteworthy.
It’s a technical “correction” in the currency, which refers to a price drop of 10 per cent or more from a recent high.
For the RBA to intervene in the market the Australian dollar would need to shift dramatically in one direction or the other, over a shorter period of time.
But that’s not out of the question in the current environment, analysts say.
Australian dollar under the pump
The Australian dollar has come under recent pressure for a few reasons.
The financial markets are now pricing in fewer interest rate cuts in the United States in 2025, from four, to perhaps two or three.
How does this affect the US dollar?
The greenback appreciates, against other countries, as the yield on US assets, like bonds, look relatively more attractive.
So, if US interest rates are seen as not falling as far as previously thought, investors buy US dollars (and sell Australian dollars) to buy more bonds.
Recently too, the Chinese yuan (CNY) has come under pressure.
There is increasing concern, analysts say, that China’s recent efforts to stimulate its economy are not bearing enough fruit.
The Australian dollar is seen as a “proxy” for the yuan and hence it’s been caught in the currency’s downdraft.
The dollar is also influenced by the price of key commodities like iron ore and coal, as well as global economic sentiment.
Both have turned down over the past six months related to ever-increasing geo-political risks and the potential for a trade war thanks to the incoming US president’s proposed new tariffs.
While the dollar has come under pressure, it’s not in freefall.
But that may change.
Headwinds facing the currency
So, what could send the Australian dollar tumbling?
InTouch senior FX analyst, Sean Callow, says round numbers, psychology and financial markets contagion.
“It would require very disorderly and dysfunctional markets, perhaps on the scale of the [2008] global financial crisis.
“[The RBA] did take action at that time.
“The market for the Aussie dollar at the time was very lop-sided.
“It was under tremendous pressure, tumbling towards 60 US cents,” Callow said.
Ominously, Callow says there is a risk the Australian dollar could again head to 60 US cents in the short term.
And that presents a problem for the Reserve Bank given its charter states: “It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank… best contribute to: the stability of the currency of Australia…”.
“Human psychology being what it is,” Callow” said, “people do watch certain round numbers in the Aussie dollar.
“Whether it’s a 60 cent or a 50 cent or what have you.
“The RBA can anticipate that the markets can be very disorderly once certain levels are broken and that there might simply not be enough buyers of the Aussie if it did fall very steeply through one of those major levels,” he said.
Reserve Bank can intervene to support the dollar
The Reserve Bank last intervened in the foreign exchange market in 2007-08 during the global financial crisis, when it bought Australian dollars.
“This was in response to evidence that large, rapid depreciations in the Australian dollar had led to excessive volatility in the exchange rate,” the Reserve Bank noted.
The RBA described market “dysfunction” as sharp changes in demand or supply causing the market for Australian dollars to become “one-sided”, or “lop-sided”, as Callow says.
A one-sided market, the RBA explains, “means that the number of sellers far exceeds buyers for Australian dollars, or vice versa.”
In this environment, the Australian dollar can become volatile; that is, it can appreciate or depreciate by a large amount very quickly.
And that’s not what we’re seeing right now.
Recent trading in the Australian dollar has been orderly.
“The trading ranges each day against the US dollar have actually been relatively small, which is what we normally see at this time of year,” Callow said.
But, he says, “if equities [or shares] are crashing on a sustained basis” that could spill over into the currency markets.
“The Aussie could become really illiquid in that case, so that might be one scenario [that would warrant RBA intervention].”
And, as mentioned, currency market anxiety around the Australian dollar falling below 60 US cents and a lack of “confidence” in the dollar at that level could also introduce some disorder to the market.
Where to next for the RBA and the dollar?
Reserve Bank currency intervention could take several forms.
The RBA could use its many billions of dollars in foreign currency reserves to buy up the dollar.
This would involve going into the market to sell US dollars (which it currently has in storage) in exchange for Australian dollars.
This process involves the Reserve Bank stepping into the market as a “buyer” of Australian dollars.
Alternatively, the Reserve Bank could indicate to global financial markets it did not plan to cut interest rates for the foreseeable future. This is known as forward guidance.
Of course, the lower the Australian dollar falls the more exporters benefit as their products become more internationally price competitive.
But I’m sure if you’re travelling soon to the United States or Britain you’re keen for the Australian dollar to appreciate from where it sits now at a two-year low.
If the currency market remains calm, but the Australian dollar keeps falling, another policy option for the RBA would be to hold off cutting interest rates.
This policy move would support the Australian dollar against the pound and greenback.
As for direct intervention, it would require a breakdown of the ordinary running of the market.
What’s new, now, is that there’s a greater risk of that, and there are no guarantees Reserve Bank intervention of the currency would run smoothly.
But we’re not there yet.
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