The Australian dollar hit a new low for the year in the fourth quarter, stopping ahead of the November 2020 low of 0.6991. It appears that the impact of commodity prices and long-term interest rates on the currency has given way to short-term interest rates and the strength of the US dollar.
Will commodities catch the attention of AUD traders?
The price of iron ore was only slightly lower in the fourth quarter after collapsing in the third. However, energy commodities surged at the end of the year.
The situation on the commodities front is best illustrated by the RBA commodities index. The index is weighted by Australian exports and remains at high levels. The above RBA charts highlight the strong contribution of commodities to the trade balance.
Note that the terms of trade are at cyclical highs. This is a big boost to the Australian economy.
Despite the perception of a slowdown in China, commodity exports continue to improve the bottom line.
Could Credit Spreads Play a Role for the AUD?
When it comes to interest rate differentials, Australia’s 1- and 10-year bond yield spreads against the US peaked around the same time the AUD / USD hit the November high. As both spreads contracted, the AUD / USD fell. However, the 10-year spread seems to have had less impact than the 1-year spread – as shown in the chart below.
It was also happening at a time when the US dollar was appreciating across the board.
The narrowing interest rate differentials and the strength of the US dollar came at a time when the Federal Reserve became more hawkish.
AUD / USD against the USD index (DXY), 1-year AU-US spread and 10-year AU-US spread
Chart prepared by Dan McCarthy, created with TradingView
In 2022, the AUD / USD appears to be at the mercy of Australia / U.S. Interest rate differentials and the U.S. dollar, while commodities appear to be out of place for now. It is the recent change of course by the Federal Reserve that is boosting rates and demand for US dollars.
The RBA has remained relatively accommodating as central banks around the world seek to aggressively tighten monetary policy. A strong Australian economy could be the factor in pushing the RBA to act and ending the pandemic stimulus.
The headline CPI sits on the edge of the upper end of their 2-3% target range, while their preferred measure of truncated average inflation sits at the lower end.
Their next meeting is in early February, at this point officials will have the Q4 CPI to factor in. With many Australian states reopening in the fourth quarter, it is possible to see a rise in prices. This could force the hand of the RBA and some hawkishness could be observed. The Australian dollar may continue to languish until the RBA changes tone.
In this scenario, the AUD / USD could weaken in early 2022 as the Fed remains on track to tighten policy at a faster pace than the RBA. A strong impression from the CPI could see the RBA spring into action in February and it could see the AUD / USD appreciate.