Why Is The A$ Falling

Imagine you have $100 to invest but you only have two options…

Country A offering 4%, or

Country B offering 5%.

Which one are you going to take?

Obviously, country B.

Now let’s suppose country B is the United States and every country around the world wants to invest there to take advantage of the higher rates.

For this to occur, each country must first purchase US dollars.

As a consequence, the increased demand pushes the US$ higher which in turn, makes other currencies look weak, especially the Aussie dollar (A$).

This is the reason the A$ has been sliding recently.

So what’s made the US attractive for investors all of a sudden?

For the past two months, bond yields in the US have gone from 3.75% up to a recent high of 4.89%…and climbing.

(Quick refresh – bonds are like a term deposit except you purchase them on an open market like stocks and shares. The bond market is also the largest market in the world – bigger than stocks, currencies, commodities, crypto – significantly, it’s the most reliable forecaster of interest rates.)

Now back to the dollar…

The reason bond yields have gone up recently is because the bond market believes US inflation will go higher which means more rate hikes for the US.

And higher rates means a stronger US$ because more people want to invest there.

Unfortunately, this pushes the value of the A$ down in relative terms.

The problem is a weak A$ (currently $0.63) has significant implications…

As the A$ slides, imports become more expensive which puts upward pressure on inflation.

This also puts the Reserve Bank in an intractable position.

They either…

Leave rates where they are and risk inflation going higher? Or,

They hike rates to attract foreign investors and force up the value of the A$. This would make imports cheaper and thus take some pressure off inflation.

The current RBA cash rate is 4.1%.

Yet history shows the ‘Goldilocks’ rate is 5% – hot too hot, not too cold.

And whilst rates at 5% would hurt borrowers (approx. one third of the housing market), it would be the ideal rate to recalibrate the economy – inflation, unemployment, A$…and the markets.

A weak A$ may give Goldilocks her ideal cash rate early in the new year.

Have a great weekend!

Adam

Back paddock – there’s only one way to find out whats inside an orange, apply some pressure – Anon