australian dollar movements

8/8/2019 Australian Dollar Movements

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Australian Dollar Movements

The following article includes information from Dr Stephen Garner of Van Eyk Research.

In mid-October, the Australian dollar breached parity with the US dollar for the first time since it was floated in 1983. Although it has since receded to just underparity level, the level of general interest has not subsided, and van Eyk is increasingly asked for its opinion on currencies, beginning with the Australian dollar. In

early October, we began a series of currency articles with “A Short History of the Aussie Dollar”, and have recently expanded our currency section in our monthly

Investment Outlook Report.

Forecasting currencies is notoriously difficult. While currencies can be influenced by a wide range of things, van Eyk views 3 key domestic factors and 5 key

international factors as most determinative in assessing the potential future course of the Australian dollar and the other key international currencies. These are set

out below.

Domestic factors:

Relative interest rates. The differential between the key benchmark rate in Australia (the RBA cash rate) and those in other countries influences the short-

term attractiveness of a currency. In November, the RBA is expected to increase the differential by raising the interest rate beyond 4.5%, while there are

unlikely to be any moves away from levels close to zero in other major economies such as the US and Japan.

Domestic equity index levels. A higher stock price index level tends to be correlated with a higher Australian dollar (see Charts 1 and 2, below). The 5 year

rolling correlation of the AUD/USD exchange rate with the ASX300 has been particularly strong since 2003. Elevated volatility, as measured by the US VIX

index, is also negatively correlated with risk assets, starting with the Australian dollar, as shown in Chart 3, below.

TWI / Terms of Trade. In Australia, the terms of trade are largely influenced by the price, rate of production and export of commodities. The recent

strength of commodities and the rise of the AUDUSD is mirrored in the high level of the Australian trade weighted Index (TWI), as shown in Chart 3, below.



International factors:

Commodity prices. Probably the most easily understandable factor. Higher commodity prices for base metals precious metals, energy commodities and

even agricultural commodities have helped the Australian dollar rally. Charts 4 and 5 below demonstrate the strong relationship of the AUDUSD with

commodities indices and commodity spot prices. There is also a strong relationship between the AUDUSD and the Baltic Dry Index, which is a measure of

global commodities shipping.

Chinese economic growth. This is the next easiest to justify. Chinese GDP growth has kept demand for commodities high, and kept worldwide economic

growth/consumption at higher levels than they might otherwise be. It may be reasonable to assume that the Yuan is unlikely to appreciate by much in the

near term, as a soft-landing is considered preferable by the Chinese government. This can be regarded as a slight positive for the near term on the

Australian dollar.

US economic growth. This is a trickier one. There is a strong argument both that further quantitative easing is priced into the equity markets (and, following

on from that, the currency markets) and that it may have limited effects on US economic growth. The US Federal Reserve appears to have committed itself

to quantitative easing if near-term economic data is poor – but if it is better than expected, then such measures might not be needed. In this case, the

expected market reaction would be an improvement in the US dollar (and a corresponding fall in the Australian dollar) as the market began to price in theprospect of future US interest rate rises that would reduce market interest rate differentials.

World political relations. These are the ‘currency wars’ that are in the news today, particularly US/China relations. With China the largest holder of US

Treasury bonds (almost US$1 trillion), a continued depreciation of the US dollar (due to low interest rates and low economic growth forecasts) makes the

US more competitive but antagonizes China more, as the value of these Treasury bond holdings declines. While Asian central banks are diversifying away

from the US dollar, there may not be any easy options for China, as it seeks to balance its own political and economic risks. In a worst-case scenario the

China would refuse to allow its own currency to appreciate (by buying more US dollars), and the US would continue to allow the US dollar to depreciate,

potentially to an extremely low level. While this might boost the Australian dollar in the short term, it would most likely have poor long-term effects, such

as national protectionism, that would most likely cause the Australian dollar to begin declining.

World equity index prices. Charts 1 shows that the AUD has been trending upwards with equities indices (depicted on a log scale) such as the US S&P500

since 2001.

Again, please keep in mind that currency is one of the trickiest things to manage, given that it incorporates views on international economics, politics, capital flows

as well as technical factors. The factors that are considered important this month may be different next month. van Eyk plans to continue updating this series with



data and commentary in future research pieces over the course of the next several months.



This publication has been prepared by van Eyk Research Pty Ltd (ABN 99 010 664 632 AFSL 237917) with information obtained from various sources deemed to be

reliable. The publication is not guaranteed to be completely accurate and should not be relied upon as such. Past performance is not necessarily indicative of futureresults. This publication is but one tool to help you make investment decisions on behalf of your clients. It is not investment advice and has been prepared without

taking into account any investor’s objectives, financial situation or needs. Therefore, you and your client should consider whether the financial services product(s)

discussed are appropriate investments for your client. You and your client should always obtain other information available from your financial adviser before

making any decision or recommendation in relation to any financial services product(s).

australian dollar movements

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