The value of the Australian dollar (AUD) rises and falls relative to other currencies around the world every day.
The Aussie dollar is tipped to trade as high as 83 US cents in 2018, according to forecasts from CommSec.
CommBank currency strategists have a base-case scenario that AUD/USD will trade higher toward 83 US cents by year-end.
AUD/USD is currently trading around 77.20 US cents having briefly moved above 81 US cents in January.
Understanding currency conversion
Exchange rates are relative prices between two currencies, which is why they’re always expressed in pairs. The AUD/USD is a code name for the Aussie dollar’s pairing with the US dollar (USD).
If the AUD/USD is around 0.75, for example, that means A$1 is worth US$0.75 or US75 cents. Flip it on its head, and where the USD/AUD rate is 1.25, that means US$1 is worth A$1.25.
Who’s buying and selling the currencies?
While we need foreign currency when we travel overseas and companies may require it to do business with suppliers in other countries, another major influence on exchange rate movements is institutions and investors trying to benefit from the ups and downs.
For example, if an investor thinks that the AUD is going to fall relative to the USD, they could use Australian dollars to ‘buy’ US dollars through an online trading platform. They would then aim to sell these US dollars once the anticipated movement occurred so they ended up with more Aussie dollars than they started with.
Currency traders buy in and out of these exchange rate pairs all day long. Of course, exchange rates don’t always move as investors expect so they can make losses as well as gains along the way.
What’s influencing the AUD/USD?
The level of demand for a currency will affect its market price. If there are more people wanting to buy AUD/USD than sell it, the AUD's value will go up. More sellers of AUD/USD means the value of AUD will go down.
So what influences whether people want to buy it or not? Some key themes that can impact the AUD/USD include:
• The outlook for global growth
• Movements in Australia’s commodity export prices, which increase or lower the nation's terms of trade – the amount of money the country brings in through exports relative to the amount it spends on imports
• The gap between interest rates in the US and Australia
• How Asian currencies such as the Chinese yuan and Japanese yen are performing
What does that all mean?
Lower global growth
Whenever global growth forecasts are being revised down, AUD/USD tends to come under downward pressure, which means the Australian dollar loses value relative to the US dollar. Generally when we see a period of increased volatility in the market we also tend to see that the Aussie dollar falls.
The US dollar is the world’s reserve currency and US government bonds are considered a relatively safe investment. So when financial markets sense an increased level of risk, the demand for these ‘safe haven’ assets tends to increase.
Commodity prices/terms of trade
Australia relies heavily on trade for its economic wellbeing. Commodities, including iron ore and coal, are some of Australia's biggest export products. A significant fall in the prices of commodities can contribute to a sharp decline in Australia’s terms of trade. Our terms of trade is a ratio of export prices to import prices calculated by the Australian Bureau of Statistics and published every three months.
As slowing demand causes the price of Australian resources to fall, it also reduces the need for Australian dollars, the currency used to buy them.
Interest rate changes
Interest rates have historically been much higher in Australia than the US for a long time now, but the momentum has been shifting.
So the appeal of buying Australian dollars to benefit from the interest you can earn on them relative to other currencies has worn off somewhat, and money has been moving back into the US in anticipation of higher rates there.
More than three-quarters of Australia’s exports are direct to Asia, and AUD is often used as a proxy for Asia. If Asian currencies are under downward pressure, in general so to is the AUD/USD.
When China’s economy was growing at full speed a few years ago, it was buying up Australian resources in order to build and develop, pushing commodity prices up as a result. Many investors recognised the Australian dollar as a beneficiary.
But conversely, when demand from China and elsewhere in Asia slows, the Australian dollar’s appeal diminishes.