Earlier this year, the Australian Dollar (AUD) fell against the US dollar (USD) by 7%. Its performance against other major currencies slowed as well, and its performance against the New Zealand dollar (NZD) was unchanged. These developments highlight the fact that the AUD is caught between the dynamics of the U.S. and China economies. Despite these developments, the currency has also enjoyed recent strength, with a positive trade balance suggesting a strong export sector.
The Reserve Bank of Australia (RBA) raised interest rates to the highest level since 1989 in May. It has since increased them by 300 basis points, compared to the Fed’s three 75-bps hikes. However, the difference in short-term rate differentials is narrowing, and the outlook for future rate increases is less hawkish than it was in 2022. This is one reason the AUD/USD pair is currently trading at a premium to the short-term rate spread. This means the exchange rate will depend on whether GBP/USD has moved lower or higher.
The Australian economy is largely influenced by Chinese demand growth. In fact, 40% of Australia’s exports are to China, and any weakness in China’s economy will weigh on the AUD. The economy has also suffered from a prolonged lockdown of the Chinese economy, which weighed on domestic growth.
The link between the Aussie and the Chinese economy is quite strong, and its influence will remain important in the second half of 2023. The AUD’s exchange rate is likely to be driven higher by expectations of China’s economic reopening, which could lead to a positive second half of the year for the currency. On the other hand, if the Fed’s rate hikes continue to slow down, as expected, the AUD/USD will take a hit in the second half of the year.
Another factor that could impact the Australian dollar is China’s interest rate policies. The Chinese COVID-19 policy has been reducing inflationary pressures, and the economy’s factory gate inflation print for the first time in two years was negative. In addition, the Reserve Bank of Australia (RBA) has set relatively high liquidity levels for the country. This asymmetry in liquidity has helped the AUD gain ground against other currencies, but its long-term outlook is uncertain.
The link between the AUD and commodity prices is also important. The Australian government has attempted to reduce its reliance on the commodity sector, and recent decreases in the price of iron ore have contributed to a decline in the AUD’s value. These factors have also contributed to the downward trend in the AUD/USD pair. This relationship is not yet in its full maturity, but it will begin to become more apparent later in the time period.
The focusEconomics Consenomics Forecasts indicate that the currency-commodity pairing decouples in 2023, with a gradual recovery of the AUD’s iron ore spot price. It is still unclear how this will impact the AUD/USD in the second half of the year, but it is possible that the AUD will remain below 0.70, and its cyclical upswing will be limited.
