The Australian Dollar Tanks As US Dollar Roars Back to Life Ahead of RBA
The Australian Dollar Tanks as US Dollar Roars Back to Life Ahead of RBA
The Aussie dollar has been on a roller-coaster ride in recent months, gaining roughly 5 cents against the US dollar. That’s an impressive feat for any currency, especially when you consider the economy is still improving and the country’s commodities prices are roaring ahead.
Commodity price volatility drives the exchange rate, but it also depends on Australian interest rates and other factors, such as ‘purchasing power parity’ (PPP). PPP theory suggests that over time, the level of exchange rates will adjust so that goods and services from Australia are less expensive in other countries than they are in Australia. This lowers the demand for Australian dollars and causes the value of those dollars to decline. This leads to a depreciation in the Australian dollar and, in turn, an increase in the value of Australian assets such as government bonds, which are more attractive to foreign investors than they were before the depreciation occurred.
As the Australian dollar moves in this direction, it is important to understand what drives this movement. Over the past few weeks, commodities prices have been booming, with iron ore up over $170 US per tonne. That’s an enormous jump from where it was at this point last year, and is the main driver of the Australian dollar right now.
The price of iron ore, and other commodities, is largely determined by demand. This means that the amount of money that investors are willing to invest in those commodities reflects their expectation for growth.
If investors expect the price of these commodities to rise over time, this will push up the value of the Australian dollar. The value of the Australian dollar can also be affected by changes in Australian interest rates, which affect the relative value of Australian assets such as government bonds.
Typically, when Australian interest rates rise, the Australian dollar becomes more attractive to foreign investors. This is because foreigners may prefer to invest in Australian assets instead of other assets, such as government bonds, that are also available in their home countries and pay a higher interest rate than Australian assets.
It’s also important to note that this higher value of the Australian dollar is not only good for consumers but it’s good for businesses as well. Companies will be able to borrow more money from the Australian economy, which will help boost investment and employment.
This is also a good thing for the RBA, which has been aggressively raising its cash rate in recent months as it prepares to end its stimulus program. But that also means that it’s reversing the long-held view that a rate hike is unlikely until 2022, when inflation is expected to reach its long-term target.
The Australian central bank’s decision to reverse course has reinvigorated a global trend toward more aggressive action from central banks ahead of the Federal Reserve, which is expected to raise its key interest rate for the first time in more than two decades next month. “The Fed is stepping up and they are front-loading rate hikes, so why shouldn’t the RBA?” asked Su-Lin Ong, head of economic and fixed-income strategy at Royal Bank of Canada.
