The past month has been a tough one for the Australian dollar, especially compared to the US dollar. As XE reports, the AUD now buys 78.5 cents, compared to a high of 81 cents in late January.
That exchange is still strong for Australia compared to a low of 73 cents back in May, but the Australian dollar has tough days ahead. Currency experts will point to higher US bond yields and the current state of the Australian economy as reasons for the ongoing decline and these are factors. But the true problem the AUD faces comes from China and the side effects of that country’s attempts to transition from a manufacturer to a consumer.
Interest Rates and the Australian Economy
Everyone knows that the US Federal Reserve and other global financial institutions intend to raise interest rates multiple times in 2018, with most financial analysts expecting a rate hike in March. At the same time, the Royal Bank of Australia has expressed its own reluctance towards raising interest rates. Ongoing struggles in the Australian economy, especially in terms of wages and underemployment, means that Australia needs further rounds of economic stimulus.
Due to the different expectations for interest rates, 10-Year US bond yields have surged since September. They currently sit at 2.91 percent, are expected to go higher, and most importantly have surpassed Australian bond yields, the first time since 2001 when the AUD only purchased about 50 cents. Higher US bond yields means lower demand for Australia bond yields, which will serve to push the AUD down.
China and Commodities
However, the impact of US bond yields remains limited compared to the more important field of commodities. The Australian dollar will not be returning to 50 cents anytime soon. This is because the demand for Australian metals and commodities will continue to remain higher than they were at the turn of the century thanks to the rise of China.
Commodities, not US treasury yields, will determine the strength or weakness of the AUD. However, there are mixed signals about which directions commodities will go.
On the positive side, higher 10-year US bond yields is a good sign for commodities. A higher yield signifies increased concern about inflation, which causes investors to turn to commodities and precious metals in particular. It signifies increased confidence in the global economy, and businesses will react by developing more mines and plantations. In an economy which is growing yet filled with uncertainties as shown in the recent stock market correction, commodities offer investors a chance for growth and stability.
On the other hand, there is the China problem. China will continue to slow down economically. And while China will continue to be a manufacturing country, the country is steadily shifting towards a consumption-driven growth model. As private equity CEO John Zhao told CNBC, “China hosts the largest middle-income crowd, growing very fast, buying things left and right, and that trend continues.”
All of these trends means that it is unclear which way the commodity market will blow, with experts predicting either a bear or bull market in 2018 to 2019. But even if the commodity market improves, the particular importance of China to the Australian economy means that the AUD will suffer from a lack of Chinese commodity demand.
Expect a Plunge
Maybe the commodity markets will pick up and boost forex Australia, thus counteracting the effect of higher US bond yields and the shaky Australian economy. But the potential of some upward pressure should not distract from the very real downward pressures which will hurt the AUD. Commodity prices will stay high enough to keep the AUD to falling to the 50 cent values it was at when their bond yields were lower than US bond yields, but it would not be surprising to see the AUD fall to 70 cents by end of 2019. At minimum, expect the downward pressures on the AUD to last for some time.