Why the Australian dollar is surging
Opinion
November 29, 2023 — 11.56am
November 29, 2023 — 11.56am
Anyone contemplating travelling to the US would be encouraged by a sudden surge in the value of the Australian dollar over the past fortnight, with the dollar trading at its highest level for almost four months.
The dollar has strengthened about 4 per cent against the US dollar in just over two weeks, from US64 cents to around US66.5¢. It touched US67¢ briefly in offshore trading on Tuesday. The last time it traded at these levels was in late July.
The US dollar is weakening.Credit: Bloomberg
While there might be an element of local influences behind the strengthening of the Australian dollar against its US counterpart, the explanation for the local currency’s strength lies more in what has happened to the greenback than in Australia’s settings.
Against a trade-weighted basket of its major trading partners’ currencies, the US dollar has weakened almost 4 per cent this month, ending what had been a four-month, 7 per cent, surge in its value. The end of that bull run has produced its biggest decline in a year.
That depreciation included a sharp 0.5 per cent fall in its value on Tuesday after Federal Reserve Bank governor, Christopher Waller – regarded as among the most “hawkish” of the Fed’s policymakers – said he was increasingly confident that the Fed’s policy was well positioned to slow the economy and get inflation back to the US central bank’s target of 2 per cent. The US inflation rate in October was 3.2 per cent.
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Waller went on to make some comments that reverberated through currency and bond markets.
“If we see disinflation continuing for several more months – I don’t know how long that might be, three months, four months, five months – you could then start lowering the policy rate just because inflation is lower,” he said.
He went on to say that there was no reason to keep rates really high when inflation was back on target.
There’s been something of a wrestle in the US and other major financial markets between those who have been convinced the Fed’s rate-hiking cycle – 11 rate rises in 16 months – has ended, and rate cuts are on the horizon next year, and others who believe the Fed, even if it doesn’t increase its federal funds rate again, will maintain it at current levels until at least late next year.
Waller’s comments are consistent with the convictions of those who believe the US economy is slowing and that the inflation rate will continue to slide to the point where the Fed can start winding the Fed funds rate back in the first half of next year.
That strengthening belief that US rates could be lowered sooner – initially sparked by the release of the October CPI data two weeks ago – is reflected in developments in the US bond market.
The yield on two-year Treasury notes has fallen from 4.93 per cent at the start of this month to 4.74 per cent. It was 5.2 per cent in the middle of last month. Similarly, 10-year bond yields have eased from 4.95 per cent at the start of the month to 4.3 per cent.
It’s the yield differentials that have dictated currency relativities throughout the post-pandemic rate hiking cycle that was triggered by the outbreak of decades-high inflation rates.
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The US hiked rates faster and harder than anyone else and the hard line taken by Jerome Powell and his governors this year, until very recently, supported the big surge in the US dollar last year and the 7 per cent appreciation that occurred between July and October this year, when the hawks in the market were prevailing and US rates were at pre-global financial crisis highs.
The Australian dollar, with the Reserve Bank still signalling the prospect of further rate rises after adding another 25 basis points in November (the last Fed rate rise was in July), is being supported by the narrowing differential between US and Australian interest rates.
It hasn’t hurt that iron ore has, at around the $US133 a tonne mark, been trading at 18-month highs, perhaps helped by China’s efforts to stimulate its manufacturing sector and its (cautious by past standards) increased investment in infrastructure as it tries to counter weakening economic growth.
While the receding prospect of further US rate rises and the bringing forward of the expected timing of rate cuts is seen as a positive for investors in equities and bonds, the underlying rationale for the shift in expectations isn’t all good news.
Rates and inflation in the US will only have peaked if the economy slows, which it does appear to be doing.
US Federal Reserve governor Christopher Waller’s comments overnight put further pressure on the US dollar.Credit: Bloomberg
US consumers are as unsettled by the inflated cost of goods and services and feeling the cost-of-living pinch as much as Australian households.
While there was some improvement in confidence reflected in an increase in the Conference Board’s consumer confidence index, released on Tuesday, expectations of the outlook for next year remain at levels that have historically foreshadowed a recession.
There are, of course, no certainties that either a soft landing for the US economy or a recession will occur, nor that its inflation rate will continue to cool. In other large economies, recessions loom even as inflation rates, while sliding, remain elevated.
The conflict in the Middle East, the war in Ukraine, the continuing tensions between the US and its allies and China, could also have either positive or negative impacts on the outlook for inflation rates and economic growth over the next 12 months.
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It does appear, however that the Fed has brought the US inflation rate – which peaked at 9.1 per cent in June last year – under control.
That is positive, not just for equities and bond investors (and gold bugs, who have seen the price break through $US2000 a tonne) but for other central banks, like the RBA, still grappling with inflation rates they consider still too high to allow complacency.
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