Current market expectations are for the interest rate gap between Australia and the US to widen to 100 basis points or more in favour of the US. If this happens, global investors risk shying away from the AUD which will see it weaken.
Commodity prices are another driver of AUD and the recent strength in base metal prices, in particular, provides an explanation why it has been resilient in the face of the change in the interest rate gap. Given the dominance of commodities in Australia’s export base, when prices of iron ore, coal, gas, gold, beef and wheat fluctuate, so do export receipts and national income.
When commodity prices are trending higher, export receipts increase. This extra export revenue boosts national income and GDP growth which in turns improves investors confidence and in turn the AUD.
The peak of the commodity price boom of 6 or 7 years ago coincided with the AUD reaching $1.10 US. The impact of what the RBA described as a “one in 150 year boom” was so powerful that nominal GDP growth approached 10 per cent, government revenue rose to the highest level ever seen and even with excessive government spending, the budget remained in substantial surplus.
Other factors, such as risk, stability of the government, foreign direct investment and importantly global economic and political news, can also impact the AUD.
For now, the volatility in the Aussie dollar around that 80 US cent level looks assured while there is conflicting news on the issues that determine its value.
If, however, the interest rate gap between Australia and the US moves strong in favour of the US over the next few months and commodity prices edge lower due to the lift in supply and a cooling in global demand, the risks favour a move towards 70 US cents.
If local political and policy risks build with the Federal election, which is due some time in the next year or so, we could even see the AUD dip below 70.