This was published 8 years ago
Australian dollar 'needs to fall another 10pc'
By Jonathan Shapiro
The Australian dollar will dip into the 50s as the economy attempts to rebalance while a dithering US Federal Reserve committee's "irrational dream" of normalising interest rates has set up the month of December and 2016 for major turbulence.
That's the view of Mark Farrington, the head of the $US7.7 billion macro hedge fund Macro Currency Group that trades financial markets with an emphasis on studying how policymakers act.
Farrington has been critical of hesitant central bankers, saying that with interest rates at historic lows and inflation models not working they are "lacking in confidence."
"If they can pass on a hard decision they will," he says.
The Australian dollar dropped sharply overnight, extending its losses for a fourth straight day.Credit: Virginia Star
Right now, however, it's his brethren that are lacking in confidence. Macro hedge funds are having one of their toughest years.
Side-swiped by extreme events like the removal of the Swiss currency peg, and two sharp reversals of the US dollar's march higher, few have delivered double digit returns, while several have shut up shop or had billions redeemed.
Farrington's London- and Sydney-based Macro Currency Group has faired better delivering 17 per cent return so far in 2015.
It did that, in large part because of scepticism that the US Federal Reserve would stay on message and raise interest rates if the data indicated they should.
Mark Farrington of the Macro Currency Group at the fund's Sydney office.Credit: Edwina Pickles
"We weren't trusting of the Fed. We traded the data, but we didn't believe the Fed was trading the data."
The year is far from over. December, usually a quite month where traders sit on the sidelines, will be massive. The Fed is finally poised to raise interest rates while four other major central banks could go in the other direction in the two weeks before. Five live meetings in the final month of the year will make for an interesting close to the year.
Will the Aussie slip below US70c this week?
"There would have been a lot of apprehension about an events calendar like that but it's aggravated by the fact that most people have lost money. Investors are not sitting on a big pad of P&L [profit and loss] this year and that is resulting in less pre-emptive risk taking. The Fed's credibility is damaged to the point to whatever they guide, no one is trusting them."
$A 'needs to fall another 10pc'
The last time Fairfax Media caught up with Farrington, in January 2014, he urged the RBA not to fear cutting interest rates to unseen levels.
A high inflation number led them to drop their easing bias shortly after but in 2015 they moved twice to cut rates to 2 per cent.
He thinks they'll go twice again, potentially before the end of the second quarter of 2016 to help the currency adjust further than it already has. The hesitancy, this time is around its currency forecasts, which should be lower.
"The Australian dollar needs to fall another 10 per cent. Looking at the 'OIS strip' [short term money market pricing] it's incredibly conservative. I don't think the market expects a full quarter point rate cut until August, which literally means not at all."
Based on previous commodity cycle turns and periods of US out-performance, the Australian dollar he says is likely to dip into the 50s before it bottoms out but should trade in a range of 62 to 69 in 2016.
The reason is that US dollar strength does little to boost economic competitiveness compared to other trading partners' currencies such as the Won, Yen, Euro and now the RMB.
"All the other components of the Trade Weighted Index are falling so it means it's not gaining a relative advantage. So it has to fall more against the big dollar to achieve a TWI bottom."
The Reserve Bank's dilemma has been the Federal Reserve, which they hoped and expected would raise interest rates and therefore weaken the currency. A looming hike is no doubt messing with their heads again.
"Like the RBA many central banks are hoping the Fed will do the work by hiking rates and giving them the weaker currency. This is a bad strategy. The reactive strategy has not served the RBA very well."
Fed's irrational dream
Farrington believes the Fed's failure to hike rates for most of 2015 sets 2016 up for major turbulence as it confronts its own indecisiveness, muddied communications strategy and clouded global economic conditions to push rates higher.
Fed chair Janet Yellen, he said, "set the market up beautifully" in February when she said that lift off wasn't as important as the trajectory - the manner and pace in which the Fed would return rates to a 'normal' level.
But he doesn't see how they get there. He expects the Federal Reserve to signal that they will raise rates at every alternative meeting but even if they do that, that's only 100 basis points of hikes in 2016, versus a projected 150 basis points implied by the "dots" – the estimates of Fed committee members.
"The ability to go at every other meeting for the entire 2016 looks to be a pretty irrational dream, given the amount of indecision that we have seen on the part of Fed," he says.
"Central banks tighten when there are excesses; to end the cycle. But this time they want to normalise gently without upsetting it. The problem is they will not be granted that opportunity after rates have been left zero for five years and haven't hiked rates for nine."
The "unobservable excesses" will reveal themselves he says, leading to spikes in volatility. This time however it will no longer be currency markets that act as shock absorbers. With global interest rates diverging volatility will transmit into other asset classes such as equities and high yield credit.
He sees a big "equity market correction" in a scenario where the Fed grapples with the process of 'normalising' rates.
"There will be some stress. This is the problem with the Fed having now cited financial conditions as a factor for raising rates. They will be causing financial conditions to tighten. There's interdependence between what they are solving for and what they are causing."