The Aussie dollar is about to face its biggest test in years, as the Reserve Bank of Australia (RBA) shifts gears while the US Federal Reserve follows a different path. What happens next could determine the future strength of the Aussie dollar and the broader economy. But what does this mean for everyday Australians?
The Unexpected Shift in the RBA’s Policy
In a surprising twist, the RBA, once expected to cut interest rates, is now preparing to raise them. Just a couple of months ago, markets were bracing for further rate cuts from the RBA. Now, things have completely flipped. Instead of rate cuts, traders are betting on rate hikes in the coming months. Meanwhile, across the Pacific, the US Federal Reserve is expected to continue cutting rates to stimulate economic growth. This divergence between the two central banks is unusual, and when it has happened in the past, it’s often led to a significant appreciation of the Aussie dollar.
According to UBS Chief Economist George Tharenou, the Australian dollar could jump anywhere from 10 to 40 percent if this divergence continues. The last time this happened, after the global financial crisis in 2009-2010, the Aussie jumped 15 percent. In the early 2000s, it soared by nearly 40 percent, reminds The Australian. What is causing this?
Australia’s Stronger Economy: The Key to the Divergence
The primary reason for the difference in policies is simple: Australia’s economy is outperforming the US. Australian GDP grew by 2.1 percent in the September quarter and is expected to grow by 2.3 percent next year, while the US economy is slowing down. Inflation in Australia hit 3.8 percent in October, well above the RBA’s target of 2.5 percent and higher than the US rate of 3.0 percent. Meanwhile, Australia’s unemployment rate has remained steady at 4.3 percent, suggesting that inflation is still a concern, though not out of control.
The RBA is now taking a hawkish stance. After its December meeting, it made it clear that it’s no longer focused on cutting rates but is considering rate hikes instead. Governor Michele Bullock has warned of the risk of inflation picking up across various sectors. On the other hand, the US Federal Reserve continues to ease its policy, even as inflation remains a challenge.
The Market Reaction: Is the Aussie Dollar on the Rise?
This situation has already started to shake up markets. Australian shares have dropped about 5 percent over the last seven weeks, while 10-year government bond yields have surged. US markets, in contrast, have seen little movement. Canaccord’s Tony Brennan believes the worst may be over for Australian assets, as the shift in interest rate expectations could provide some stability for the Aussie dollar.
However, a puzzle remains: why hasn’t the Australian dollar surged as much as expected, given the widening gap between Australian and US interest rates? Historically, a sharp increase in bond yield spreads has led to a stronger Aussie, but this time, the dollar hasn’t moved as much, at least not yet. UBS expects the currency to catch up with the rates market, possibly with a delay.
What’s Next for the Aussie Dollar?
Looking ahead, a rising Aussie dollar could have significant effects on different sectors of the market. With rising rates and a stronger dollar, some sectors—like resources and materials—are likely to perform better, while others, such as consumer stocks, may struggle. Macquarie equity strategist Matthew Brooks suggests it’s time for investors to adjust their portfolios to account for the late-cycle environment, with inflation pressures likely to continue.
