The Australian Dollar, Aussie, or just AUD, is the currency of Australia.
AUD is one of the eight most important currencies in FX markets.
It is issued by the Reserve Bank of Australia (RBA).
And it belongs to the group of Commodity Currencies.
This means the price of the Australian Dollar fluctuates (often, but not always) with price of commodities Australia exports.
But is that the only driver of AUD price, or are there more?
I already let the cat out of the bag with Commodity prices as a driver of AUD value in FX markets.
However, we haven’t talked about which commodities.
Before we do that though, let’s step back and list the major drivers:
First and foremost: RBA’s interest rate decisions, and other tightening/loosening policies, especially when they change expectations.
Second: How well Australia’s economy is doing (momentarily) as expressed by price and demand of the commodities it exports.
Would you like me to go over each one?
The Australian Dollar’s price often varies with that of iron ore.
Australia is the world’s
largest exporter of iron ore, according to Australia’s
department of Industry, Innovation and Science (here).
Back when I was a Central Banker, one of my many functions was watching international commodity prices, and learning about the industry.
And while my main task was figuring out how price moves in the markets would affect my country’s economy (a small country, heavily dependent on trade)…
I got acquainted with some of the big players in global commodity markets.
And I mean BIG players.
Two of the three biggest commodity companies globally are BHP Billiton and Rio Tinto.
Turns out both behemoths have their key iron ore mining operations in Australia.
Yes, both companies are at the very top of the list when it comes to exports of iron ore, among other commodities.
So what’s the point?
Since Australia’s economy get a serious boost from strong iron ore exports, price and quantity of this commodity affects how investors see Australia.
In FX markets, this means traders will discount the Australian Dollar (AUD) when exports are low (either on price or quantity).
The reverse is often also true.
How do you know commodities are low?
Through news feeds, you’ll often read (or hear) how AUD is suffering/boosted by weak/strong commodities.
This is preferable to trying to check commodities yourself, since shifts in that market aren’t always reflected in FX.
Let me repeat that.
This is not a rule of thumb! AUD price doesn’t always go hand in hand with commodity prices.
It does so often, but a good chunk of the time, it doesn’t
Because other, more important currency drivers are likely taking effect.
And this almost always means traders are paying attention to something the Reserve Bank of Australia (RBA) did or said.
But before we jump into Monetary Policy as a driver, let’s mention one more thing…
We spoke of price of commodities such as iron ore (there are others as well, but that’s the most important one), however, what about quantity?
Someone must be demanding commodities from Australia, right?
Well, the major destination of Australian exports is China.
Not surprising, given their geographical proximity (and the sheer size of the latter).
Hence, when you read about big shifts in China’s trade balance, or a strong move in the Yuan’s valuations (the currency of China):
This can affect the Australian Dollar (AUD).
And it often does.
If China’s imports shrink, then they may stop buying some of Australia’s commodity exports (one country’s exports are another’s imports).
Even if commodity prices remain the same, a decrease in demand will drop the $ amount received by Australia’s economy.
This affects AUD twofold:
Australian Dollars stop being bought to secure the goods; and
Australia becomes less attractive for investors (hence, they will not buy AUD to invest in the economy).
Note: international trade often takes place in USD, however, in our simple example, China sells yuan to get USD, while Australia receives USD (and some of these USD are then sold for AUD).
Ok, but how do shifts in Yuan price affect Australia and AUD?
The key is in the note above.
If Yuan falls steeply, it becomes more expensive for China to buy goods and services from abroad (now they have to give more Yuan for the same amount of foreign currency).
Hence, China’s imports decrease, and the scenario described above plays out.
Conversely, an appreciation of the Yuan would make it easier for China to import stuff from abroad, since they can buy more with the same amount of Yuan.
Thus, exports of commodities from Australia may benefit from such a move.
But remember, these moves don’t always hit AUD.
First, they have to be strong, not so frequent moves.
Second, they have to occur when there isn’t something more powerful going on:
And we close this piece short and sweet.
The single biggest driver of a currency’s valuation is non-other than its interest rate (and other conditions which affect supply/demand like QE in the US, though that ultimately served to lower rates).
Thus, a country’s Central Bank, the entity with power to determine monetary policy, (interest rates and other, quite interesting tools) is always followed by anyone who cares about FX.
Their influence is so far reaching that anything from stocks to bonds to real estate (practically everything) is shaken by it.
And currency is the most affected of all.
Therefore, keeping an eye on monetary policy in Australia is a must. Since the RBA’s decisions dominate AUD price now and always.
Just in case, higher rates = higher AUD and vice versa.
See you soon,
The Forex Economist
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