The definitive guide to the RBA’s ‘passive intervention’ in the AUD

A lot of ink has been spilled by various FX strategists over what the Reserve Bank of Australia is or isn’t doing with its FX transactions — and whether this is or is not tantamount to printing money.

The reason for the fuss is twofold. First, some unusually large amounts began appearing in the RBA’s foreign exchange holdings in the past three months. Second, the RBA did not appear to be offsetting these flows by buying AUD, as they might normally be expected to do.

The high Aussie dollar has been something of a bugbear for the RBA (among others) recently, but the currency has been high for quite some time now and the RBA isn’t seen as the sort of central bank to undertake a bold intervention strategy at the current levels. Its reputation is for being fairly conventional.

One the one hand we had Gareth Berry of UBS saying the RBA is very likely PRINTING MONEY:

The Reserve Bank of Australia may have recently begun printing Australian dollars to satisfy overseas currency demand from foreign central banks. We find the evidence for this is compelling (but not yet conclusive).

And on the other hand, Richard Grace from the Commonwealth Bank was saying there’s absolutely nothing to see here:

In our view, the suggestion that RBA is conducting “passive” intervention to lower or cap the AUD appears fanciful. In this instance, “passive” intervention is defined as a deliberate policy decision not to convert foreign exchange received by the RBA into AUD. In effect, it would be a policy decision to absorb the foreign exchange onto the RBA’s balance sheet, so as not to put any additional upward pressure on the AUD.

Anyway, RBA governor Glenn Stevens apparently put the whole debate to rest last night, in answering questions after a speech in Melbourne. The RBA hasn’t yet published the transcript and audio of the Q&A, but they usually do this within a day of the speech.

From Nomura’s Geoffrey Kendrick:

Martin Whetton (Sydney rates strategist, cc’ed) just asked Governor Stevens about this “passive intervention” point, during his Q&A in Melbourne

Governor Stevens responded that “It was customer business and we felt we’d like to take it on the balance sheet”.

In other words, it was passive intervention, with the RBA taking a view on the level of AUD.

We don’t know if “passive intervention” is really the right phrase — because it’s an oxymoron.

But we’re quite sure now on what this means: the RBA is opportunistically signalling that it does not like the AUD being so high and investors should perhaps take note. The opportunity was presented by a foreign client leaving an unusually large amount of AUD deposits for an unusual length time.

(And let’s be clear here: the amounts under examination are nowhere near enough to have any material effect on the exchange rate — we are talking a total of about A$1.3bn.)

So, let’s break down what actually happened:

Mystery number 1:

‘Other outright’ transactions on the RBA’s monthly foreign exchange holdings accounts [warning: XLS file] moved rather steeply in the past few months. Here’s this item charted over the last two years:

The recent levels are less remarkable though if you go back more than a few years — although it still shows a sharp upturn in recent months:

Okay, but what are these “other outright” transactions anyway? Here’s the actual definition:

‘Other outright’ transactions include the RBA’s outright transactions with other central banks, international financial institutions which are not intended to affect the exchange rate, clients other than the Australian Government, and interest received on holdings of foreign assets.

Presumably the ‘interest received’ isn’t very big and the rest, well, who knows? But it doesn’t seem that this item is for intervening — it’s just a category for miscellaneous forex transactions made with the RBA. (Incidentally foreign market interventions are and all recorded in this spreadsheet — and it has listed mostly zeros for the last 20 years.)

Nevertheless, there is an unusual increase in foreign holdings of AUD by foreign institutions.

Why is this?

It’s well known that various other central banks have been interested in buying AUD (or more specifically, Australian government bonds). If they choose, these institutions can carry out their purchases via the RBA. We’ve heard from a couple of sources that these particular purchases are due to a certain central bank choosing to put some money in its RBA account and leave it there for an unusually long time before making its purchase of Australian governments bonds, or whatever it is that they’re planning to buy.

No, we don’t know which central bank it is, sorry! But feel free to guess. There are quite a few to choose from.

But all we really want to know right now is: IS THIS PRINTING MONEY? Which brings us to…

Mystery number 2: Is the RBA doing something, or not? If so, what?

Well, one could argue that yes, yes it is printing money. Because when a foreign institution wants to deposit some money with the RBA in AUD, the RBA gains a forex asset and an AUD liability.

However, we’d say: no, absolutely not — unless you really are missing the point about what money is. Money in the RBA’s eyes is simply cash plus the “Settlement Exchange” accounts, which is the commercial banks’ holdings at the RBA. And this entry onto their balance sheet is neither of those, so it doesn’t affect the money supply.

However… this is where it gets interesting. The RBA are doing something. Or rather, they are NOT doing something. That is, they are NOT offsetting these relatively large (though in the scheme of things, still very small) foreign deposits by buying up a similar amount of Australian dollars. The RBA is only offsetting the government transactions, and not these “other outright” transactions.

Why?

Well… this is where we get into “signalling”. And here is where we will again quote from a note by ANZ strategist Andrew Salter, because his argument makes the most sense to us, based on our understanding of the RBA’s balance sheets and tactics, and he used to work at the RBA. And here’s what he says:

- Accommodate a small portion of foreign portfolio demand for Australian dollar denominated assets.

- Send a signal to investors positioning for an appreciation in the currency on the basis of foreign demand that it is prepared to absorb part of it, and therefore that such positioning may not be as profitable as may be perceived

- Prepare for the eventual unwind of foreign demand by building up its coffers of foreign exchange.

The very messy details:

Here’s how it works. If we look again at the monthly foreign exchange holdings accounts [XLS] we can make an educated guess at what did or didn’t happen.

Here is a screenshot of the spreadsheet in question, with the actual foreign exchange transactions highlighted:

Interesting, right? Okay, not very interesting at all, but let’s look at those columns:

1. “Market”: Stuff the RBA does in the, er, markets. Deliberately. Here’s what the ‘Market’ column means on this spreadsheet:

‘Market’ transactions are foreign exchange transactions against the Australian dollar (excluding foreign exchange swaps) undertaken by the RBA with authorised foreign exchange dealers in Australia or banks overseas.

Not very helpful, but clearly this is something that the RBA actually DOES. In other words, transactions the RBA carries out itself of its own volition, or whatever. Only, we can also deduce that it doesn’t carry out these transactions to affect the exchange rate, for all sorts of reasons including the reason that they are simply not allowed to do that.

2. Australian Government: Government transactions such as paying staff in overseas embassies and so on… (yawn).

3. Other outright: As discussed above, this is basically odds and ends including transactions with other central banks.

4. Swap deliveries. Let’s forget that for now, because it’s used for liquidity management and moves around a lot particularly when there are, say, big government bond redemptions or big tax payments.

5. Total.

Okay so, ignoring the ‘Swaps’ column means we have to make our own ‘Total’ column by netting the first three columns and… well now, those last three months still look interesting don’t they?

Or, in the longer term, this column would look like this:

It moves around a lot because of course some crazy things happened in late 2008, and in 2009 there was a big IMF payment (SDRs and the like show up in the ‘Other outright’ column) but since then it’s been quite flat.

What does this tell us?

Well, we are back where we started really:

1. There’s been some strange increase in foreign holdings of AUD in the region of $400m+ a month, in the past three months; which the RBA isn’t orchestrating because it can’t.

2. The RBA is choosing not to offset this amount through market transactions.

Why this does matter: The RBA is deliberately not offsetting this unusual transaction, sending a signal to the markets that it doesn’t like the higher AUD.

Why it doesn’t matter: If it did offset the amount, it would have to undo that when the said foreign depositor actually goes ahead when they get a chance.

What next?

Well, now Stevens has confirmed it was indeed a ‘customer transaction’ that made the Other Outright (really it couldn’t have been anything else). Which means the money will be spent buying whatever AUD-denominated asset the central bank/client wants to buy.

So, at some point the flows stop (which will show here) and the forex assets on the RBA’s balance sheet will diminish by a billion dollars or so (here) — in fact this has already begun to happen.

We’re guessing this will play out sooner rather than later, because the yield on say Australian government bonds, (not to mention “semis” or state govenrment bonds) is considerably higher than what the RBA pays on deposits.

Related links:
The passive-aggressive RBA – FT Alphaville
Statement on Monetary Policy, August 2012 – RBA
Foreign Exchange Market Intervention - RBA