What the Aussie dollar is telling us about the Iran war

What has happened to the Aussie dollar?

The Australian dollar has held up better than many might expect during what has been a period of heightened global uncertainty.

The Aussie is often seen as a “risk-sensitive” currency. When investors become more worried about the global outlook, they often move money towards assets and currencies seen as safer, such as the US dollar. Australia’s economy is also closely tied to global trade and demand for commodities, so concerns about slower global growth can put pressure on the Australian dollar.

Commonwealth Bank Economist and Currency Strategist Carol Kong says the AUD has recovered across a range of major currency crosses since the most intense phase of the Iran war.

In a research note, Kong said AUD/USD was solid  and near its highest level since June 2022. She also said the Australian dollar’s recovery has been broad-based, with major AUD cross rates back near pre-war levels.

That means the Aussie has not only held up against the US dollar but has also recovered against a wider group of major currencies.

What are currency crosses?

Most Australians are familiar with the AUD/USD exchange rate, which shows how many US cents one Australian dollar can buy.

Currency crosses look at the Australian dollar against currencies other than the US dollar, such as the euro, British pound, Japanese yen and New Zealand dollar.

That broader view can be useful because the US dollar often moves for its own reasons during global shocks. Looking at cross rates can help show whether the Australian dollar itself is holding up, or whether another currency is doing most of the moving.

What is the Aussie dollar telling us?

Kong says the Australian dollar’s performance suggests markets are looking at the Iran war mainly through the lens of inflation.

“AUD’s resilience, despite the unresolved conflict, suggests markets view the shock as more inflationary than recessionary,” she said.

That means investors appear more focused on the risk of higher prices, particularly through energy markets, than on the risk of a sharp hit to economic growth.

Inflation and interest rates are closely linked, so the distinction investors are making is important.

If investors think a shock will keep inflation higher, they may also think central banks need to keep interest rates higher for longer. That can flow through to bond markets, where yields often rise when investors expect higher rates or stronger inflation.

Why do bond yields matter for the dollar?

A government bond is a way for investors to lend money to a government in exchange for regular interest payments. The yield is the return investors get for holding that bond.

Bond yields matter because they can show what investors expect from interest rates, inflation and growth.

When Australian bond yields are higher than those in other major economies, Australian-dollar assets can look more attractive to global investors. That can help support the Australian dollar.

Economists call this Australia’s yield advantage.

Kong said the Reserve Bank of Australia’s rate rises, and the chance of more to come, had helped support the Australian dollar.

“This has shifted market focus on interest rate differentials which currently favour AUD,” she said.

Could that support fade?

CommBank does not expect the Australian dollar’s recent strength to last indefinitely.

Kong said CommBank expects Australia’s yield advantage to narrow over time, which could weigh on the currency.

“Looking ahead, we expect Australia’s yield advantage to narrow and weigh on AUD,” Kong said.

That means the same force helping the Australian dollar now could become less supportive later.

CommBank expects AUD/USD “to peak soon” before declining to 0.64 by year-end.

So what’s the takeaway?

The Australian dollar is not saying the Iran war is over, or that markets are relaxed about the risks.

It’s saying investors appear to be treating the conflict less as an immediate recession shock and more as an inflation and interest rate story.

For now, the Aussie dollar’s message is that markets are watching not just the war itself, but what it could mean for prices, central banks and returns on Australian-dollar investments.

Read Carol Kong’s full research note: AUD/GBP defies broader AUD pullback