The Australian Dollar (AUD), as evidenced recently by its stunning strength, is no different. It rose past the 0.6200 level on a broad-based US Dollar weakness and changing factors of trade. Underlying this volatility are drivers that inform the value of the AUD. The Reserve Bank of Australia (RBA), volatility in iron ore prices, and the state of China’s economy are big players.
The RBA controls Australian’s interest rates by setting the baserate for how much they will lend to each other. This monetary policy is to keep inflation around 2-3%, which is remarkably stable. By adjusting interest rates up or down, the RBA influences borrowing costs and, consequently, consumer spending and investment. The delicate balance of interest rates and inflation has a powerful influence over the AUD’s value.
The RBA’s Role in Shaping the AUD
The Reserve Bank of Australia is an interesting example of using a limited range of tools to shape the economy. Of these, interest rates are the key factor. Specifically, by increasing or lowering these interest rates, the RBA hopes to accomplish its main objective of keeping inflation stable within Australia. Similarly, when inflation climbs above its 2 to 3 percent target range, the RBA can raise interest rates to slow economic activity. On the flip side, if inflation goes too far under target, it will be forced to lower rates to spur economic activity.
Yet unlike the Fed, the RBA strikes an active posture toward traditional interest rate changes. Second, it uses quantitative easing and tightening to determine the state of credit conditions. However, quantitative easing typically weakens the AUD as it increases the money supply. When monetary authorities tighten measures, one sees a positive response of the currency since the measures bring down inflationary pressures. These measures affect investor sentiment, sometimes producing overreactions and substantial movements in the AUD’s value.
Market participants watch RBA announcements and all economic data pointing to the health of inflation and growth in the economy with extreme focus. Any indication of a shift in policy direction can lead to immediate fluctuations in the AUD, as traders react to perceived changes in economic stability.
The Impact of Iron Ore Prices
In addition to interest rates, the other major Australian Dollar driver is Iron Ore prices, one of Australia’s largest exports. As such, Iron Ore is considered the proxy for the demand for Iron Ore, which directly influences the demand for the AUD. Rising prices are increasing Australia’s terms of trade, an index measuring the trade balance per unit of exports. This balance is the excess of earnings from exports over payments for imports. A surplus trade balance is bullish for the AUD as foreign buyers would need to buy more AUD to purchase Australian goods.
When Iron Ore prices are up, Australia’s export profits are through the roof. This surge further boosts investor confidence in the AUD. This increasing demand for Australian exports leads to an increasing surplus that serves to further appreciate the currency as that tipping point breaches. When Iron Ore prices drop, it lowers trade balance too. This economic downturn creates serious downward pressure on the AUD.
To understand this intertwined nature of commodity markets, traders and analysts keep a hawkish eye on global commodity markets and price movements in Iron Ore. They know that any negative changes in this sector can quickly undermine AUD. That’s why it’s so important to be tracking these trends and forecasts.
China’s Economic Influence
Whatever the case, China is of course Australia’s largest trading partner. Consequently, its economic wellbeing has a strong impact on demand for the Australian Dollar. When China’s economy is booming, sending demand surging globally, that lifts Australian imports of agriculture, minerals, and manufactures, and services. This increased demand leads to a higher AUD as even more foreign currency flows into Australia in exchange for AUD.
When, for instance, China’s economic growth slows or underperforms, demand for Australian exports can dry up. Given the deterioration in economic conditions, traders are going to scramble to reprice. This economic shift is a contributing factor to the decline in value of the AUD. Thirdly, Chinese tertiary growth data can produce upside and downside surprises. These movements directly impact the AUD and its trading pairs.
Australia’s economic fortunes are still overwhelmingly dependent on its economic ties to China. Therefore, even the slightest indication of growth slowdown in China can lead to immediate knee-jerk reactions in the Shanghai foreign exchange market. US investors are extremely focused on Chinese economic trends right now. They are particularly keen to model how these indicators would influence the Australian economy and the AUD/USD exchange rate.
Technical Indicators and Market Sentiment
Technical analysis has an increasingly key role to play in determining the current trends influencing the Australian Dollar. These 20-day, 100-day, and 200-day Simple Moving Averages are key indicators that traders use to gauge market momentum and signal buy/sell decisions. At the moment, these averages are sloping downward and hovering overhead of near-term price action, adding a lid of sorts on any potential AUD gains.
As always, market sentiment can change quickly, influenced by not only fundamental but technical signals as well. Geopolitical Factors Traders also take a big picture view of economic conditions and major international events when assessing their positions in currencies like the AUD. The interaction between these multiple forces makes for a fluid environment that investors operating in currency markets should be acutely aware of.