Notes From Underground: Aussie checks; Brazil raises; and Brian Sack speech reveals a lot about the DUDLEY CALL

Monday night the Australian Central Bank decided to hold the lending rate at 4.5 percent rather than raise to 4.75 percent as 80 percent of economists predicted. It appears that the RBA is very concerned about the global growth story and the recent strength in the AUSSIE DOLLAR. As expected, the Aussie currency sold off sharply as the market was disappointed that the bank is on hold for the moment. We were in the camp that the Aussies would check because of the recent Aussie dollar strength but something else bothered us.

The 2/10 curve in Australia is in to 20 basis points and another interest rate rise would probably have resulted in an inverted curve, which would suggest that the RBA was overly tight. As long as the global growth story is positive, the AUSSIE should hold its recent rally as there is no question that the RBA is one of the few banks that is ahead of the monetary curve. The strength of the Australian mining sector is very real and gives the Australian economy a tremendous tailwind. Throw in a robust agricultural sector and the Aussie currency has potential for higher levels. Yes, it will even get help from the FED.

The best growth story in the Western Hemisphere has been Brazil. It has everything that Australia has and even higher real rates of interest. All of the pluses for Brazil have been a major boost to the REAL but the Brazilian authorities have been trying to slow down the currency appreciation. For the second time this year Brazil has moved to raise the tax rate on foreign investment in Brazilian bonds. The first tax did nothing to forestall REAL appreciation, so Monday the finance minister announced a doubling of the rate to 4 percent in order to slow the inflow of foreign money seeking Brazilian debt. It will probably take another doubling of the tax rate to curb the Brazilian bond market being the darling of the global carry trade.

The 10.75 percent interest rate on money in Brazil, with an appreciating currency, is the paradigm of a classic currency carry trade. To stem this and prevent the Brazilian economy from overheating inflows are going to have to be penalized without destroying the Brazilian economy. Monday’s announcement was just one more attempt to halt capital inflows without outright capital controls. The Brazilians have been a major recipient of globalization and don’t wish to stop it but rather just to assert some control. Finance Minister Mantega warned about currency wars last week. Today he fired another warning shot.

Quick Hit: NEW YORK FED EXECUTIVE VICE PRESIDENT Brian Sack delivered a speech in Newport Beach. It is a must read for the thinking of those on the FED who favor more QE and is evidently the work that prompted the speech by William Dudley. We always read the work of Sack for he is regarded as one of the main thinkers and researchers behind FED think. The speech, titled “Managing the Federal Reserve’s Balance Sheet,” is a good look at what the FED thinks in regard to the balance sheet.

The FED extended its purchases in the August meeting because they realized that the success it had in shifting the long end of the curve was forcing the repayment of MBSs which was leading to the FED actually draining liquidity from the system, so the alternative was to buy Treasuries to insure that the liquidity stayed steady. The rapid repayment of MBS was causing the FED balance sheet to contract as the recovery was losing pace. This is just one tidbit but the speech is worth the read.

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3 Responses to “Notes From Underground: Aussie checks; Brazil raises; and Brian Sack speech reveals a lot about the DUDLEY CALL”

  1. Arthur Global Practice Says:

    Yra check FT Lex about Greece today, you’ll love the first sentence… The country that gave us Euclid is learning that 2 + 2 = 4

  2. Jess_T Says:

    Would you consider the ability of AUDUSD buyers to absorb offers and then bid it to new highs for the week in the face of surprising (bearish) RBA news a reaffirmation of bull dominance?

  3. yra Says:

    Jess—yes as the aussie becomes the recipient of anything but the U.S. dollar trade—after all the aussies are still ahead of the proverbial curve–see today’s blog as to a near term caveat though for if the u.s. equity market rallies it may give the FED some room and actaully placate the HOENIG group and then we would see a sell off of all things that have rallied since september 21 fomc statement

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