The Australian dollar has recently been rallying strongly against the US dollar. After plunging to a 17 year low of 57.18 US cents on 19 March, it has since recovered dramatically. At time of writing, one Australian dollar will now buy 70 US cents. With the Australian dollar generally viewed as a “risk” asset, why has it been strengthening amidst the COVID-19 pandemic?
Iron Ore Prices
The Australian currency is heavily correlated to the commodity prices. When commodities do well so does the Aussie dollar. When global growth was stagnating earlier in 2020, we saw the Aussie dollar falling. Most recently though, competing iron ore countries such as Brazil have had to shut down mines due to COVID-19 infections. This has suppressed supply, thus driving up the price of iron ore. This is good news for Australian iron ore miners and therefore for the Australian currency. Iron ore needs to be purchased with Australian dollars. When demand increases for iron ore, so does the AUD.
Rotation out of safe havens
During the COVID-19 shut down, investors were feeling fearful about the economic future. This meant that they were rotating out of risky investments and putting them into safe havens. The US dollar is considered a safe haven and is popular during times of turmoil. US Government Bonds are another safe haven asset class which is in favour during economically fragile times. Because the pandemic situation is now improving globally, demand for both these assets are now declining. This has decreased the demand for the US dollar which is now weakening the currency rate. The AUD has seen stronger movements compared to the US as investors move out of safe havens denominated in USD. When there is confidence in the economy, investors want to invest in assets generating higher yields such as equities and the Australian dollar.
The COVID infections rates in Australia have been a lot better than the numbers from the US or Brazil. Australia’s ability to flatten the curve has contributed to the rise in the value of the Australian dollar. Currency investors may see the economic recovery from Australia better than other countries and therefore flock to Australian dollars.
Australia’s official cash rate of 0.25% is higher than other countries. The US official cash rate is 0% and the rates are negative in Japan. Australia’s positive interest rate may look more favourable to currency traders compared to other countries. To obtain a higher return on cash via Australia’s interest rates, overseas investors would therefore need to buy Australian dollars. This in turn drives up the price of the AUD.
Lauren Hua is a private client adviser at Fairmont Equities.
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