Investment Opps

The US Dollar and interest rates


The Australian dollar has largely tracked sideways in a 76-78c band against the USD for the last 6 months. But it was the US FOMC meeting in mid-June which changed things.

Currencies largely track the supply and demand of a nation’s goods and services (terms of trade). Investments and borrowings form a part of this (current account surplus/deficit), and that’s why interest rates, net debt, and money supply are factors.

Over the 6 month period, the Australian 10 year bond yield has largely been similar to the US equivalent. Normally investors demand a higher rate of return from Australian government debt, as we are seen as a “risky” country. But our government debt isn’t as bad as other nations (see redline in chart below), our economic growth is reasonable (circa 3%), our unemployment is trending lower, and our goods (iron ore) and services are in demand.

Conversely it is the US which is a riskier proposition with a growing debt pile (black line), but equally stronger economic growth (circa 7%) and rising inflation (5%).

At the FOMC meeting in June, the Fed Chair Powell basically turned a blind eye to inflation, and instead backstopped the loose monetary conditions (low rates and $140b of bond buying per month). Ordinarily this would be enough to weaken the USD, but instead it strengthened. The secret was in the “dots”.

Each FOMC meeting, Board members are asked to plot where they think interest rates will be, and this allows full transparency to the market of how the Fed may move in the future. The June meeting revealed participants were anticipating 2 rate hikes in 2023 – bringing forward previous estimates.

Not long after this announcement did the RBA confirm they were keeping their “supportive monetary conditions”, noting that the pandemic is not over and that Australia still has a long way to go to achieve an inflation rate of 2-3per cent. This means the RBA is unlikely to move until 2024, putting it behind the US… and in turn changing the interest rate dynamic between the two countries. As a result, we have seen the AUDUSD break its 6 month range, and trading slightly weaker at around 74c.

NAB see the currency at 80c by year end, a view not shared by the Commonwealth Bank. The CBA say the USD will appreciate over the remainder of 2021 because of US economic outperformance.  But, they expect other countries will catchup in early 2022 (on increased vaccination programs) which will see the USD weaken.

As a result, the CBA believe the AUD/USD can weaken into the end of 2021 because of the outlook for a stronger USD, the RBA’s relatively dovish stance, and commodity prices which are likely to decline over the coming 12 months. The CBA see the currency at 72c US by year’s end.

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