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The Aussie dollar is down: Why that’s not so bad

Aussie 50 dollar notes being printed.
The Aussie dollar has fallen against the USD, but it's not as bad as it seems. (Source: Getty)

Amid current global financial market turmoil as central bankers flounder to implement policies to tackle the once-in-forty-year inflation problem, the Aussie dollar (AUD) has been crunched.

Or has it?

At one stage this week, it fell below 64 US cents as global investors struggled to work out the best place to park their funds amid policy ructions around the world. Talk of a pending global recession and a drop in some key commodity prices had a big impact on the AUD.

The fall in the Aussie dollar was, however, somewhat complicated by the fact that virtually all other currencies were also smashed lower against a booming US dollar.

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The media attention to the US 64 cents was a distraction from the fact that the AUD is actually strong against most other major currencies – the Euro, British pound, Japanese yen, Canadian dollar and New Zealand dollar.

On a trade weighted basis, which measures the AUD against a basket of global currencies, it is broadly flat trading around the levels at the start of 2022 and even in the period immediately before the arrival of COVID.

This resilience means that fears of a currency problem for the Reserve Bank are low-key.

Indeed, the AUD’s broader stability is a source of comfort rather than concern for policymakers even though against the USD it is markedly weaker.

It remains unlikely that there will be any material impact on inflation from the moves of the Australian dollar, even though many commodities and imported items are priced in US dollars.

European exporters, for example, still convert their revenue to Euros. And against the Euro, the AUD is tracking strongly.

The price of a car made in Europe, for example, might actually be cheaper in Australia in the months ahead because of the relative strength of the AUD versus the Euro.

Looking ahead

It remains a challenge to judge how the AUD will trend in the remainder of 2022 and into 2023.

It is increasingly likely that the Australian economy will outperform many other countries which is often a magnet for global investment funds.

At the same time, the Federal budget next month is likely to confirm a genuine and substantial move to repair the budget, a fact that should support Australia’s AAA credit rating and with that investor support.

The interest rate differential between Australia and the world is likely to work against the AUD.

The RBA appears to be setting the scene for a moderation in the monetary tightening cycle, just when the likes of the US Federal Reserve, the Bank of England and even the European Central Bank are hiking in big steps.

When there is huge economic uncertainty, as there now is, many financial market prices overshoot their true value. When this happens, investors are reluctant to be the first to fight these trends, for fear of being steam-rolled by the market momentum.

It could be said that the current spike in the USD, the surge in bond yields and the fall in stock markets are all an overreaction to the fundamentals.

If so, the turn could be soon, although many investors have lost good money trying to trade the turning point.

But over the more medium term, say the next 3 to 6 months, when the dust settles for the inflation fears and central banks sit back and move to ‘on hold’ decisions for monetary policy, the USD is likely to reverse and with that, the AUD should rebound against it.

A move back into the US$ 70 cent region.

In terms of how it goes against the other major currencies, some weakness against the Euro would seem most likely in these circumstances.

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