Carry is King (in RBA FX interventions)

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Forget efficient markets, in Fixed Income & FX Carry Is King.

So it should be no surprise that carry has typically played a key role in the profitability of RBA FX interventions.  The Bank’s most recent assessment of FX intervention is RDP 2004-06 — which uses Friedman’s profitability test to assess the RBA’s three pre-GFC interventions in the FX market. The fourth was in 2008/9, and also realised handsome profts, as you can see from the Valuation gains and losses figure in this post.

In all cases, the RBA intervened to tighten monetary conditions — selling foreign reserves to buy AUDs. Consistent with this, they were also tightening monetary policy, so their actions to reduce the supply of AUDs were consistent with their interest rate and inflation objectives.

A consequence of this tightening campaign was that domestic interest rates were higher than global interest rates.  As a result, the RBA made a profit on their portfolio switch (selling lower yielding assets to redeem higher yielding central bank liabilities). Thus, the Bank booked a gain just from holding their intervention portfolio – a profit that’s a handy buffer against the vicissitudes of the FX market.

Between 1983 and 2004, the realised profits from intervention were ~2.5bn and the carry was ~2.4bn.  Unrealised profits were ~300m, for a total gain of ~5.2bn.


  1. You say “In all cases, the RBA intervened to tighten monetary conditions — selling foreign reserves to buy AUDs.”

    But each time they sell AUDs they are, intentionally or not, suppressing the FX rate compared to the outcome when they maintained a fixed foreign balance sheet and let markets alone set the price.

    If I recall, there is also a period in 2008 where they sold a lot of foreign reserves to support the AUD. Perhaps now is a good to to accumulate more foreign reserves with a high AUD in case such a situation arises once again, and they need to defend the unofficial $USD0.60 floor.

    Seems logical to me.

    1. I am sure are deliberately and with intention selling AUDs, and know it lowers the price and adds to AUD liquidity when they do so. At the same time, they are usually sterilizing by selling securities from their portfolio to keep the monetary base where they want it.

      Why not just grow the profitable portfolio? Most western central banks do not think it wise to take so much risk on a long term basis. Most also think that operating with negative capital is a bad idea.

      I think you are convinced that the AUD is overvalued – if it truly is overvalued, there is little downside just now to them selling FX. However if that were what the RBA thought, the RBA’s inflation forecast would be lower – if inflation undershoots their forecasts, they will ease policy. I think we agree on that.

      My bet is on lower rates rather than FX sales.

      We shall see…

  2. I remember the RBA intervention during the GFC… the AUD was dropping vertically, panic all around and it went from 0.98 to 0.60 in 3 months! The RBA intervened because of the speed of the decline and to stabilize the currency: they were not defending any particular level. The AUD could have dropped further easily. I think they’d do the same if the AUD goes to 1.30 in the next 3 months, or to 0.70 for that matter.

    1. Agreed, smoothing is their normal MO. It is interesting to think about what lots of selling at this level might mean when the boom truly ends – unless the RBA wanted to have an ever-larger balance sheet, it would mean unwinding and thereby preventing the AUD from weakening. I think that is bad policy,vas it is just at that point when we will want and need a weaker currency to raise the returns on capital in our manufacturing and other export industries (and import competing industries).

      Actions now have consequences later.

      1. Maybe we should just stop thinking about a weak currency altogether. We will never be able to (or want to) compete with low-cost producers anyway.
        We should instead focus on productivity and the high AUD is forcing the issue.

      2. ssec, around a decade’s worth of productivity growth is required to overcome a 10% increase in the currency (assuming from some stable level). It is completely unimaginable that there is any level of relative productivity growth (our gains compared to everyone else’s) that could offset a 10% increase in the currency within the next 20 years. I have no idea what you propose to focus on.

        1. Hmm, it is a big hill to climb, but i think we should aim for it – better to focus on something like productivity, which is a target we can hit. A few decades of better productivity growth would be welcome, and something we can bank on regardless of FX.

          Talk of selling the AUD to stop structural change seem dim to me. It is a blunt subsidy.

          Why not just go for a direct taxpayer subsidy if you are so sure that retaining some particular sector is very important?

      3. Stop making stuff that anyone can do…. make stuff that we only can do and do it more efficiently and better. The list is long. Tourism, mining, wine, education. It’s a long term proposition, but a necessary one. Better than thinking that our future is in the hands of a depreciating currency.

      4. Ricardo – who do you believe is subsidised from selling the AUD? (or buying)
        ssec, I’d say Australia has no advantages in wine, tourism, education – compared to where? And how would tourism improve productivity to offset the AUD appreciation?

        If other countries are happy to manipulate their currencies lower, we can never win through productivity gains, no matter how great – since other countries can still make those industries uneconomical by manipulating their currency even lower.

        Talk of productivity is a cop out, and a distraction from the political and financial games being played internationally.

        1. Intervention to lower the foreign exchange value of a currency transfers resources from the non-tradables sector to the tradables sector. Seems to me that most of the cries for intervention come from tradables.

      5. ” I’d say Australia has no advantages in wine, tourism, education ” No, I disagree here.

        Anyway, mine were just some examples. Germany sells BMW no matter where the EUR is at. Or look at Nestle for Switzerland. Do you think Google would collapse with a stronger USD? Apple? Microsoft?

        So you think the RBA should intervene and take the AUD down to…. what? 0.90? You think 10% would make such a big difference? Would we then be able to compete with Chinese manufacturers? Or would tourists and students rush to Australia then?
        We would pay petrol and other commodities 10% more, wouldn’t we and have more inflation? The real problem with Australia has been *inflation* and excessive debt in the last few years. That’s the real problem. And if we need a strong dollar to cure that, well it’s welcome.

        Just my opinion… feel free to disagree! :) I like to learn from others and discussing openly makes my thinking better (hopefully!) :) cheers

        1. I am a little firmer still on this point – productivity is all that matters in the long run. It matters for long term FX valuation, and it matters for our standard of living. Talking about it and doing something to improve it is always the best thing we can do.

          The point is not to point to sectors, the point is to point to the large and ongoing decline in unemployment over the entire period where we dismantled trade and assistance policies.

          The button plan and subsequent reforms cut tariff protection from near triple digits to almost zero – and we do not have either an industrial wasteland nor a sea of unemployable workers.

          Talk of selling the AUD to lean into the 10tn balance sheet expansion by central banks is little different from putting up tariffs and quotas to ‘protect’ us from subsidized foreign goods. and it is probably just as futile.

          We cannot tax ourselves rich…

  3. ricardo,

    I don’t buy all that ‘productivity is all that matters in the long run’ nonsense anymore – especially when people think they are referring to multi-factor productivity. If MFP is simply the residual measure when we try to add all inputs and subtract them from outputs. It is simple a measure of our inability to measure properly. It’s like saying all that matters in the long run is our limits to understanding.

    Labour productivity though, is important. But we know that it grow mostly (say 90%+) through capital deepening – investing in more infrastructure and equipment.

    Therefore, to win the productivity battle, and indeed to beat the world in productivity gains for multiple decades, we would need the most massive capital investment program around – similar to they way the Asian manufacturing centres have developed historically. That we can’t compete is a product of THEIR proactive policies to promote a long boom in capital investment, and out complacency in thinking that the market was perfect and that they were somehow ‘naturally’ better.

    Think about Japan’s post WWII rise as a manufacturing powerhouse. They did this by keeping the currency low and fostering a massive export market – to the extend that the world’s superpower forced them to let the YEN appreciate so they could protect their domestic industry.

    If a high AUD is so great, why doesn’t the RBA buy some more – boost the AUD even higher? If it’s costly to put a lid on the currency, it must be an absolutely brilliant investment to keep it high, and make it go higher.

    1. Australia is a high investment country. We have a current account deficit not because we have a savings problem, but because we invest a lot.

      As for the RBA boosting the AUD, i am against that too. Though it would probably be profitable, as it is the positive carry trade…

      Why do we have to so either? How can you be so certain that capital markets have got it wrong?

      1. Because there is no reason to assume they have it right. And recent history is pretty clear about that relying on that assumption is problematic. The current level of the AUD is literally off the chart (on your first chart).

        Is allowing the AUD to swing between $USD1.10 and $USD0.60 really in the best interests of long term investment? Does stability, and particularly stable expectations, have a value?

        So your basic position is that the right level of the AUD is whatever it happens to be as a result of domestic policies in other countries (their capital controls, regulations affecting the attractiveness of foreign investment etc), the decisions by foreign investors (who we know like to run with the herd, regardless of the costs of volatility), and indeed the direct intervention of other countries to ensure that the AUD remains relatively high. That seems pretty naive.

        Also, the CAD is high because foreigners invest a lot. High domestic investment won’t result in a persistent CAD.

        I still don’t understand how you think that buying AUD now is more profitable than selling. You own charts show that selling high, buying low is the way the RBA can profitably intervene. Yet now at record highs you suggest buying even more AUDs will be the profitable transaction – because the RBA could act like an investor and run with the herd, until the rest of the her bolts.

        1. It has positive carry. Historically, buying the high yielding leg is profitable.

          Anyhow, that’s not my argument, and neither is it yours.

          My argument is that the AUD is not overvalued. The RBA shares this assessment. It is maybe a little high, but it is not wildly over-valued. That is why we have trend growth, around target inflation, and near-full employment.

          I happen to think that things are turning down, so i expect rate cuts – but right now, demand and inflation are around where most would say is ‘appropriate’. The RBA does not share my forecast so they are on hold.

          What the ‘overvalued due to CB buying’ crowd need to explain is why all the other investors are not seeing it and selling out. Surely if CB X takes the AUD to the moon, all the other capital will just leave Australia and sell their AUDs?

      2. @Cameron Murray : but you still haven’t said what is the alternative.

        What’s the right level of AUD then? Or what’s the max – min? How do you peek those levels? Would it be linked to commodity prices? Or vs a basket of currencies, like the Chinese? or vs a specific currency like the Swiss. What happens if commodity prices surge again and we limit the AUD? Would we prioritize max inflation or max AUD?

        And why trust markets at all? We should also put a min-max under the ASX200. Let’s say it can’t go below 4000 and not above 5000.

        Markets may not not be perfect, they may be irrational in the short term, but fundamentals do count in the long term…. if the AUD is in a bubble, like many say, and does not reflect real economic fundamentals, then it will come down (I believe it will, but not as much as we were used to). We still have one of the lowest unemployment rate in the world and population is growing, isn’t it? Why wouldn’t you own AUD right now? Tomorrow…. everything can change in a flash and markets can turn in a second.

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