Currency Watch: Why Did The Aussie Dollar Fall And Where Is It Headed?
Editors Note: The Currency Watch column will undergo a new format starting this month, as contributor and financial analyst Nathan Carroll takes a more in-depth approach to his mid-month market analysis for each region, and will also be opening up the forum to our audience to contribute questions concerning foreign currency with a chance to have it included in the next Currency Watch column.
Since the beginning of 2013, the Australian dollar has been on a sharp decline (13% YTD) and it doesn't seem to be slowing down. So what went wrong? Well, lets examine the events leading up to 2013.
If we take a look back down memory lane to the year 2007, we had the GFC (global finance collapse), however, the Aussie dollar was inversely effected and maintained a strong technical chart: every new move led to a new high and every dip was followed shortly after with a rebound. Even though volatility has reached intense levels during the past few years, the chart for the Australian dollar remained steadfast. Thus, its safe-harbor status was never breached in a technical sense. Furthermore, this encouraged speculators and investors to buy the dips whenever global trouble loomed therefore strengthening the Aussie dollar further. So what caused these changes? Lets dig deeper.
To understand why the Aussie dollar has dropped roughly 13% YTD you need to take a look into the key variables that influence its price movement. This can arguably be broken down into five:
• Australian Interest Rates
• Commodity Pricing
• Chinese Manufacturing
• U.S. Housing Market
• U.S. Dollar Index
Australian interest rates affect the value of the Aussie dollar significantly. For example, on January 1, 2013, Australian interest rates were averaging 5.4% over the last 10 years, and as of late, have dipped to 2.5%; so why the significant drop? Well, when interest rates are high, Australian bonds present a good investment opportunity for foreign investors; thus the demand for the Aussie dollar increases and the price reflects as such. However, when interest rates drop, so do bonds and the demand for safe haven currencies.
Factor number two, commodity pricing, may be the most influential factor of all. As some of you may know, iron ore is the primary ingredient for steel manufacturing, and also one of Australia's largest exports. In February 2013 the price of iron ore composites fell approximately 30% YTD which reflects upon the trade value of the Aussie dollar. So what caused the sudden decrease in iron ore demand? China, the global source for inexpensive manufacturing. Because China is one of Australia's largest trading counterparts for precious metals (iron ore), as China's economy slows so does Australia's. Therefore a lower demand of Australian exports has a direct correlation to the movement of the Aussie.
To make matters more difficult for the Aussie, the North American housing market is recovering. Although U.S. fiscal challenges loom and monetary policy is still very loose, markets are beginning to price-in stabilization to the former and a tightening in the latter. This stabilization of the U.S. housing market lures new foreign investors who had previously invested their money in Australian bonds and by some, viewed as less risky. This is factor number four.
Factor number five: In the world of foreign exchange, the US dollar has recently been viewed as the least volatile against its major trading counterparts. Therefore, as the US dollar index rises it is hitting a variety of asset classes, including gold which inversely affects the trade value of the Aussie dollar.
Below is a chart showing the YTD downward trend of the Aussie to US dollar YTD:
So what does the future value of the Aussie dollar look like? Well, according to the latest news reports from China, not good. Many experts believe the Aussie dollar will continue to decline as we move towards the end of the 2013 until it reaches its equilibrium point. What this is, no one can be sure but know this: we are not there yet.
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About The Author: Professional surfer in Hawaii for over 10 years and has always been passionate about global economics and international markets. When he retired from surfing he joined the FX Sales &Trading team at GPS Capital Markets, Inc. (www.gpsfx.com), a Corporate Foreign Exchange Firm. Currently, he is working with a variety of global action-sports brands helping them improve their processes surrounding FX transactions. Through identifying and managing their foreign currency risk, these companies are better protected and adapted to the volatile market conditions.