For much of the previous century, the Australian dollar was pegged to the British pound, and even with the US dollar for a brief duration. It was only in 1966 that the AUD was launched as a decimal currency after Australia’s financial system’s deregulation.
Come 1983, the AUD/USD pair (commonly referred to as the Aussie) started to gain traction in the backdrop of strengthening gold, iron, and copper exports. At the tail of the last century, Australia’s exports stabilized and the AUD’s sustained growth pumped power into the currency.
The AUD/USD claims a spot among the world’s most widely traded currencies. Let’s look at the factors that drive the value of this pair and understand the correlation it shares with macroeconomic and other factors.
Interest rate differentials
Interest rate differentials are perhaps the most prominent factor driving the price of AUD pairs. They emerge from the opportunity cost of investing in Australian assets versus assets in some other country.
While speaking of AUS/USD, of course, we compare the yields between American and Australian assets. For example, if the RBA decides to bring the interest rate (aka cash rate in Australian parlance) up to 2% once the pandemic ends, and the Fed keeps the US interest rates unchanged at the current 0.25%, investors will sell their USDs and buy AUDs to invest in Australian assets.
The demand for AUD will rise, and ceteris paribus, the AUD/USD will trade in the green.
Prices of Commodities
AUD is often referred to as the ‘commodity currency’ since the currency’s price is strongly driven by Australia’s key commodity exports and the country’s overall terms of trade.
Higher commodity prices mean other countries, including the US, will need more AUDs to buy commodities exported by Australia. The increased demand can push the AUD/USD quote upward. In other words, the AUD will strengthen against the USD.
When US GDP data releases and people learn it missed the expectations, currency prices move quickly. Central banks view GDP as a key metric to gauge a country’s economic health. A significant upward or downward deviation can cause the market to swing in the blink of an eye, consequently affecting the AUD/USD prices as well.
However, there is another country that affects the price of AUD/USD—China. China’s GDP data and economic health are particularly important for the Australian economy because a lion’s share of its minerals is exported to China. A slump in Chinese GDP figures will likely cause the AUD to depreciate against the USD.
Price of Gold
Australia is the world’s third-biggest producer of yellow metal, exporting about $5bn worth of gold each year.
Quite intuitively, gold and AUD/USD share a positive correlation. This means, when gold prices surge, the AUD/USD quotes in the green, and vice versa. The correlation is amply strong, too, with historical data points showing an r of 0.8.
Note that this also means that gold shares a negative correlation with the currency pairs that have USD as the base currency.
The AUD/USD pair is a trader’s gateway to the Asian market and perfect for those who want to still deal with a largely western-based financial structure. Historically, it has been said that the AUD/USD pair ‘goes up the escalator, and down the elevator shaft’ because the pair’s price rallies at a moderate pace, but falls fairly quickly.
Nevertheless, AUD/USD continues to be a fundamentally appealing pair. Traders with enough risk appetite and a well-formulated strategy can reap profits from this highly liquid currency. It enables them to leverage global growth that is often hard to find in any other major currency.
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