AUD/USD, or Australian dollar to US dollar, is a major currency pair and is heavily traded in forex markets. Given the scale of Australian commodity exports destined for China, the currency is frequently seen as a proxy for Chinese growth. This is especially the case given trading restrictions on the Chinese yuan. During boom times, AUD/USD offers attractive interest rates and tends to appreciate. During economic downturns, the pair tends to sell off sharply. Given the US dollar's status as a safe haven, investors tend to retreat to the dollar when perceived risk is high.
In our last commentary on the Australian dollar, we wrote that the currency was an enticing short opportunity thanks to slowing Chinese growth and a bearish trend. Specifically, we recommended shorting AUD/USD as means to express a bearish view on the currency. Since that time, the pair has weakened (from 0.7560), and is trading around 0.7280 on August 13. Going forward, we see further...
In our previous take on the Australian dollar in late February, we wrote that falling commodity prices, an ongoing slowdown in China, and weak domestic conditions (looking at both economic data and monetary policy expectations) were significant headwinds for the currency. Beyond economic indicators, quantitative signals also suggested that the bullish trend was running out of steam. We downgraded…
We take a closer look at the Australian dollar forecast, and how domestic and international economic changes are set to impact the currency. From China's slow down to key domestic indicators that reveal slowing growth, we break down why we're changing our outlook on this commodity currency.
In our previous commentary on the US dollar, we wrote that the buck was set to rise further thanks to our forecast for slowing US growth and inflation. Given the US dollar’s safe haven qualities, the currency performs the best when economic conditions deteriorate. Following the publication of our last commentary, the performance of the US dollar index (a measure of the currency against major pee…
In our last commentary on the US dollar, we wrote that the buck was set to move higher given underlying economic trends. Specifically, US growth and inflation was likely to keep accelerating, while the opposite was likely to happen in most major regions outside the United States. Following the publication of our last commentary, the US dollar index has strengthened from around 91.80 to around...
In our previous commentary on the US dollar, we warned that a weak dollar was hiding significant risks in growth-sensitive assets such as equities and European currencies. As the world’s reserve currency, the buck is inversely correlated to most financial assets because most cross-border lending is conducted in dollars. Thanks to a slowdown in economic growth outside the United States coupled wit…
Significance of the AUD/USD pair
AUD/USD is a major currency pair, meaning it is among the most heavily traded pairs in the foreign exchange market. The US dollar is the most traded currency in the world, while the Australian dollar is the fifth-most traded currency. The US dollar and the Australian dollar tend to move in opposite directions over time.
As a global reserve currency and a safe haven, the US dollar tends to depreciate when global economic growth is strong, and strengthens during downturns. Given the Australian dollar’s strong correlation with industrial commodities (Australia is a leading exporter of iron ore and copper), AUD tends to appreciate when commodities rally during global economic booms. During a downturn, the Australian dollar tends to sell off sharply. Relative GDP growth rates for Australia and the United States are shown below:
2006 – mid-2008: Pre-financial crisis boom
In the years preceding the financial crisis, optimism for global growth was running high. Thanks to booming volumes in cross-border lending, the US dollar was easily available and kept depreciating during this era. As the world’s reserve currency, the US dollar is a liability currency, meaning that is heavily borrowed in international lending markets. When global growth is strengthening, more and more US dollar loans are issued and chase international investment opportunities. The US dollar thus weakens in response. Given Australia’s high rates of GDP growth and relatively high yields (the Reserve Bank of Australia increased its cash rate from 5.50% at the outset of 2006 to 7.25% by early 2008), the country was an attractive investment destination during this time. Looking at AUD/USD, the pair strengthened from around 0.75 and peaked above 0.98 in July 2008. While the Australian dollar experienced a sharp sell-off in mid-2007 following early tremors in US real estate, the currency recovered and began strengthening once again. Until the US downturn starting in 2007 morphed into a global crisis in 2008, many believed that problems in US real estate would be contained.
Mid-2008 – early-2009: The global financial crisis
Starting in July 2008, the Australian dollar began selling off sharply. During that month, IndyMac (a spin-off of Countrywide Financial and a leading subprime mortgage lender) went bankrupt. Rising fears regarding a broader crisis soon led to steep sell-offs in bank stocks around the world.
Prior to the crisis, Australian banks were heavy borrowers of US dollars from offshore lending markets (known as the “Eurodollar” market – note the term “euro” denotes an offshore currency as opposed to the Eurozone’s currency). As Eurodollars were plentiful and fairly inexpensive to borrow, Australian banks found that building their reserves using borrowed Eurodollars was cheaper than raising retail deposits. Australian banks then issued loans (mostly in Australian dollars) in the form of mortgages. Put another way, Australian financial institutions were effectively short the dollar. While this trade worked well when the US dollar was weak and the Australian dollar kept strengthening, it fell apart once the financial crisis resulted in a sharp appreciation of the US dollar.
In mid-2008, Eurodollar lenders began doubting the creditworthiness of foreign financial institutions following a series of bankruptcies. As borrowers were unable to rollover their US dollar liabilities, they sold their assets (such as Australian dollar mortgages) in order to repay US dollar loans. The US dollar thus rose sharply while the Australian dollar began a steep sell-off. Looking at AUD/USD, the pair bottomed around 0.64 in February 2009.
2009 – early-2013: Swift recovery
After bottoming in early 2008, AUD/USD soon began a steep ascent. Unlike the US which experienced a severe recession, Australia was one of the few countries in the world to emerge from the crisis mostly unscathed. Furthermore, the Reserve Bank of Australia began hiking interest rates in late 2009, helping widen the interest rate differential between AUD and USD. The US Federal Reserve, on the other hand, maintained interest rates at 0% during this time and engaged in several rounds of quantitative easing (buying mortgage and government bonds using the Federal Reserve’s balance sheet).
The Australian dollar was also supported by the strong rebound in industrial commodities such as copper. As China announced a substantial stimulus program focused on infrastructure investments following the crisis, commodity prices strengthened in anticipation of stronger global demand. As Australia is a leading commodity exporter, its currency strengthened as a result.
Looking at AUD/USD, the pair strengthened to around 0.92 by October 2009. Following a brief sell-off in early 2010 driven by USD strength, the Australian dollar once again began rising. The pair made its long-term peak above 1.10 in July 2011. The pair mostly traded sideways until early 2013. In April 2013, the pair made another long-term peak around 1.05.
2013 – 2016: Emerging markets downturn
Starting in early 2013, GDP growth in emerging markets began decelerating. New Chinese loans (a front-runner to emerging markets economic growth), peaked in the last quarter of 2012 and began sharply decelerating. Chinese new house prices (which are fairly sensitive to changes in new credit), also began declining in late 2013. In response to lower Chinese growth, the Reserve Bank of Australia began cutting interest rates, lowering the positive interest rate differential against the US dollar. Other indicators relating to growth such as copper prices (one of Australia’s leading exports) also entered a bearish trend during this time. Looking at AUD/USD, the pair ended the year below 0.90.
The bear market in AUD/USD accelerated in 2014 thanks to the sharp fall in crude oil prices and the euro. Lower commodity prices and a lower euro had the result of strengthening the US dollar by a significant degree. As a result, the Australian dollar to US dollar exchange rate fell further. By the end of 2014, the pair was trading just above 0.80.
Unfortunately, the bear market continued in 2015. Both Chinese growth and commodity prices kept falling, hurting the Australian dollar in the process. AUD/USD ended the year above 0.69. The pair had not traded at such a low value since the 2008 financial crisis.
2016 – 2017: Rebound and recovery
While many believed that China was headed for a “hard landing” in 2016, its fortunes reversed and the country entered an upswing. Looking once again at leading indicators such as new Chinese loans, a significant stimulus program in late 2015 helped the economy strengthen in 2016. Commodity prices also rocketed higher in 2016, and especially industrial commodities most sensitive to Chinese growth such as copper.
Looking at AUD/USD, the pair ended 2016 just below 0.73 and ended 2017 around 0.78. Relative to previous recoveries, gains in the currency were fairly mild as the Reserve Bank of Australia was hesitant to raise rates. Thanks to an ongoing housing boom funded by significant consumer borrowing, the RBA was hesitant to catalyze a downturn in the housing market. Despite rising expectations for rate hikes in 2017, the RBA maintained rates at 1.50% throughout the year. As comparable US interest rates rose to 1.25 – 1.50% by the end of 2017, the interest rate differential favoring AUD had fallen significantly by the end of the year.