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Normalization Down Under - Global Exchanges

FICC Podcasts July 06, 2021
FICC Podcasts July 06, 2021


In this week’s episode, we discuss today’s RBA policy announcement and what the market is pricing in for the RBNZ. We contrast those currencies to a few ADXY currencies.

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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:                Hi, welcome to Episode 14 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my cohost Stephen Gallo and I will be discussing today's RBA policy announcement. We will compare it with the baby steps taken toward normalization recently by the Fed, BOC and RBN debt. We will contrast Aussie and Kiwi with a few ADXY currencies. The title for this episode is, "Normalization Down Under."

Stephen Gallo:                  Hi, I'm Steven Gallo, a London-based FX strategist. Welcome to global exchanges presented by BMO capital markets.

Greg Anderson:                Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Steven's cohost.

Stephen Gallo:                  In each weekly podcasts like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:                We strive to make this show as interactive as possible. So don't hesitate to reach out by going to Thanks for joining us.

Disclaimer:                          The views expressed here are those are the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Stephen Gallo:                  Greg, it's July 6, 2021. This is going to be our first podcast of the third quarter. And as you mentioned in the intro, it's going to focus partly on the Reserve Bank of Australia. And incidentally we're launching Episode 14 of global exchanges on the same day as the RBA's monthly policy announcement. Just cutting right to the chase, what stands out to me from the Central Bank's official statement is that they're now being more specific about the cap for the weekly asset purchase pace, $4 billion Aussie to be exact. And to the best of my knowledge, they weren't doing that before, they weren't being specific about a number.

                                                So it looks like, to me, there's been a slight normalization of policy from the RBA. But it also looks very much like they're using the publicized figure, much as the Bank of Canada already does, for a transparency and communication tool with the market. Am I reading this the right way?

Greg Anderson:                You are, but let me back up for the sake of our listeners, and contrast what the RBA has done since the start of the pandemic with other central banks, like the Fed and the BOC.

                                                So back in March of 2020, when all the central banks cut their base rates to the zero lower bound and initiated QE, the RBA had its own couple of unique twists. So first, it implemented a yield-curve control program, something that the Fed and the BOC didn't do, with a target three-year interest rate of 25 basis points.

                                                Second, it created a funding for lending facility that it called ... It's TFF, term-funding facility. This facility provided three-year lending to banks provided they were taking the money and using it to lend to businesses, particularly small and medium-sized businesses. The RBA, at that stage, didn't initiate a traditional X amount per month type of bond purchase program.

                                                However, in November of 2020, with Aussie rebounding sharply, the RBA came in with a second stage. It cut its base rate down to 10 basis points. And it also launched a traditional bond purchase program on top of the yield curve control bond-purchase program.

                                                So that program was initially announced as $100 billion Aussie over six months. I guess market participants could have done the math on that and said, "Hey, that averages out to $5 billion a week," but it wasn't communicated that way. And the market expectation was, "Hey, maybe that bond purchase program could be lumpy, some more in one week than another." And in fact, the purchases were lumpy back in February, when we had the global yield spike. The RBA bought more, they front-loaded purchases.

                                                At any rate, after the initial six-month period of that program was drawing to a close, the RBA announced another six-month, $100 billion Aussie extension that would take us through mid-September. So again, if you worked out the math, it was $5 billion a week, but the RBA primarily communicated as $100 billion over six months.

                                                So long story short, yes, there has been a noteworthy communication shift now to where they are talking about a pace per week, like other central banks. I guess most of the central banks are pace per month, but they have said pace per week. And then they've left it open as to when this pace will next be re-evaluated, other than to say, it will be at least through mid-November.

Stephen Gallo:                  So basically Greg, if I read you right, what you're saying here is there hasn't been a whole lot of policy normalization from the RBA. They've gone from $5 billion a week to $4 billion a week. Is that it?

Greg Anderson:                Yes and no. There's nuance here. I will point out that the FOMC's June median dot brought the Fed's forward guidance for the first rate hike into 2023. While the RBA continued to say in this announcement that its base case is no rate hike until 2024. So that's less of a normalization than the Fed. And I'd argue that it's less of a normalization in the BOC also because the BOC has communicated that it thinks Canada's output gap will close in mid 2022. And yeah, as you pointed out, a taper from five to four isn't much.

                                                However, the other thing the RBA did was to end the TFF on June 30th. And the termination of that program was cold turkey. It wasn't done in gradual steps. I think the RBA was nervous about the market reaction to the tightening of that screw, so they didn't want to tighten other screws very much. But I don't think that because this taper was only from five to four, that the next taper will - and that presumably would be announced in October or November - will be from four to three. It might be from four to two or something like that.

Stephen Gallo:                  Okay, Greg. So I guess this isn't a bad time to bring the RBNZ into the picture. And it looks to me, on that front, like the markets are pricing in or close to pricing in, and the central bank is signaling a move up in the base rate as early as next year, sort of around mid 2022 or the second half of 2022.

                                                Now I know from my own experience at the RBNZ is a targeter of macroprudential tools and it focuses very much on financial stability risks in the housing market. So talking about hiking rates and actually delivering a rate hike, those are two different things. And I'm mindful of that. But you seem to think that despite what the RBNZ is saying now, you seem to think that there are other factors that are going to weigh on the Kiwi relative to the Aussie, right?

Greg Anderson:                With the RBNZ, I would actually say that they're doing their very best to hide any type of forward guidance. They didn't mention a projected first rate hike in their last interest rate announcement. And then, in the summary of their quarterly inflation report, they left that out too. They did bury deep in the statistical annexes of that report a projection of the first rate hike being in Q3 of 2022.

                                                But look, I would just say the RBNZ is dealing with a different mix of issues. So the rise in housing prices in New Zealand is a highly sensitive political issue, and that has caused the Finance Ministry to press the central bank to get it to fight house price appreciation. So where the RBA seems really worried about Dutch Disease, the RBNZ is more worried about a housing price bubble.

Stephen Gallo:                  All right. All right. So Greg, let's redirect this conversation back over to currencies, particularly Aussie and Kiwi versus the US dollar. What are your thoughts there, given the central bank backdrops you've just described so much of?

Greg Anderson:                Given the central bank backdrops, and more importantly, given the commodity price backdrop, I don't think the recent dips in Aussie US and Kiwi US are warranted by the fundamentals. In fact, I'd say Aussie USD is a steal at 75 cents with good potential for a rally back up to 78 in the next few months. And for Kiwi, I think it's a steal below 70 with a good potential for rally back up to 72 or 73 over the next few months.

                                                Doing the two, I guess I like Aussie a bit better because its commodity terms of trade looks a bit better than New Zealand's. Australia's imports of energy as a share of GDP are smaller than New Zealand's. And then the price of its export basket has done better and has better future prospects, I think.

                                                But let me turn the tables here. If I think that we can see a rally in Aussie and Kiwi due to commodity prices and central bank normalization, what's your view on the ADXY? I mean, Aussie and Kiwi are normally correlated with ADXY, right?

Stephen Gallo:                  Well, Greg, you're acting a little bit like the tail wags the dog with that line, but really, at the end of the day, it's China that is very often, if not always, in the driver's seat of the ADXY.

                                                Let me talk a little bit about what China has done with its policy normalization. So, 2020 was a tremendous year for the Chinese economy in terms of the speed with which it rebounded from COVID-19 and the timing of it being very early, relative to Western economies. It then started to normalize the credit cycle earlier this year. And now it looks like they've basically just paused. I would say with their recent liquidity injections and withdrawals, they're not really signaling anything major on the horizon. They're keeping things pretty steady. And short-term RMB rates, that is onshore RMB rates, they're pretty flat, they're pretty stable.

Greg Anderson:                So Steven, with what you've said about Chinese authorities' policy responses, we've seen the exchange rate just die in the 640s over the last several weeks. Do you think that's by design?

Stephen Gallo:                  Yeah, I do. Greg. I think the PBOC are more than comfortable with dollar RMB in the 640/650 range for now. And I think that range ties up with the extent to which regulators have tempered the domestic credit cycle in China.

                                                And look, they're probably reasonably satisfied with the RMB appreciation they've had since the 2019/2020 low point in economic activity during the pandemic. And also what they've received in terms of inbound capital flow since the trough in financial market activity or financial asset prices last year.

                                                So yeah, if anything, what the PBOC has been doing has been holding back or holding down the ADXY.

Greg Anderson:                So let's say that a dollar RMB stays flat in a narrow range. Are there any ADXY currencies that might appreciate, either due to a central bank normalization story or a commodity prices are really high story?

Stephen Gallo:                  Well, Greg, you raise an interesting point and I think that the behavior of some of the other components of the ADXY partly explain the PBOC's reticence as far as RMB appreciation is concerned. So if I look at the Korean won, the Indonesian rupiah and the Malaysian ringgit, all three of those currencies are trading towards the low end of their one-year ranges versus the Chinese renminbi.

                                                Now Indonesia and Malaysia, those currencies are both typically commodity plays, even though in the case of Indonesia, it's not a net crude oil exporter. But my point is that their respective central banks are probably going to lag behind the RBA and the RBNZ on policy normalization because of where their economies are in dealing with COVID and the rolling out of the vaccines. So this is despite the fact that commodity prices generally have been well-supported. But they're basically well behind in terms of dealing with COVID and rolling out the vaccine.

Greg Anderson:                Hey, Stephen, I noticed you mentioned early on in your discussion Korea. And of course, it's a commodity importer, not an exporter. But it's an importer whose economy is doing relatively well. Is there a chance that BOK hawkishness could cause appreciation in the Korean won?

Stephen Gallo:                  Well, actually, Greg, I think one of the reasons that the BOK has turned a bit more hawkish is the fact that the currency is not trading excessively strong right now. So you have a number of different factors weighing on the Korean won, which are making it easier for the BOK to talk about normalization. China has slowed the appreciation of its currency. You've got oil weighing on net importer currencies, like Korea. It's a great time for the BOK to sneak in hawkish rhetoric and possibly even a rate hike without causing a huge appreciation of its currency.

                                                And one of the reasons why they would want to do that, that is talk about policy normalization, is because of asset prices. They've been on the receiving end of significant capital inflows over the past six, nine, even 12 months as a result of Western central bank stimulus and the hunt for yield, that those inflows have complicated financial stability risks in South Korea.

                                                So the BOK wants to sneak in some policy normalization. They also probably want to put a break on some of that inflow. So they want to temper the rise in asset price. And the currency being where it is now is a good opportunity for them to do that.

Greg Anderson:                Hey, I think this is a pretty good place to end it. What do you think?

Stephen Gallo:                  Yeah, that sounds good to me, Greg. Thanks, as always, to our listeners for joining us. We'll be back with Episode 15 of global exchanges in two weeks on July 20th. All the best for now.

Greg Anderson:                Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Speaker 4:                           This show and resources are supported by our team here at BMO, including the FIC-Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

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Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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