The Australian dollar (AUD) is the official currency of Australia and its territories. Also known as the Aussie, the AUD is the fifth most traded currency in the world. As an export driven economy, the Australian dollar is often impacted by commodity prices. Understanding the factors that influence the AUD can help traders capitalize on opportunities.

A Brief History of the Australian Dollar

The Australian dollar was introduced on 14 February 1966, replacing the Australian pound. The AUD was decimalized in 1966 when Australia adopted a decimal currency. One Australian dollar was equivalent to ten Australian shillings.

Prior to 1966, Australians used the Australian pound, which was introduced in 1910 and pegged to the pound sterling. Australia was part of the Sterling Area, a group of countries that pegged their currencies to the British pound sterling. This changed after the Bretton Woods agreement in 1944, which pegged world currencies to the US dollar rather than the pound sterling.

In 1966, Australia decimalized its currency and established a new peg to the US dollar at A$1 = US$1.12. This peg only lasted until 1971 however, when the Nixon Shock unpegged global currencies from the US dollar. Since then, the Australian dollar has floated freely on foreign exchange markets.

Some key events in AUD history:

  • 1983 – Australia adopts a floating exchange rate regime, allowing the AUD to fluctuate based on supply and demand.
  • 2001 – New polymer (plastic) banknotes are introduced to replace paper notes and improve security.
  • 2011 – The AUD reaches parity with the US dollar for the first time. High commodity prices drive up the Aussie dollar.
  • 2012 – Reserve Bank of Australia cuts interest rates, sending AUD lower against other currencies.
  • 2020 – AUD falls to 18-year lows against the USD during the Covid-19 selloff before rebounding swiftly.

AUD Exchange Rate Regime

Australia currently follows a floating exchange rate regime, meaning the external value of the AUD is determined by foreign exchange markets. Supply and demand for the currency determines how much the Australian dollar is worth relative to other currencies like the US dollar.

Unlike some countries that peg their currency to another currency or benchmark, Australia allows the AUD to float freely. The Reserve Bank of Australia (RBA) and government sometimes intervene during periods of volatility to smoothen exchange rate fluctuations, but generally the AUD is determined by the forex market.

A floating regime provides the RBA flexibility in setting interest rates to target inflation rather than maintaining a currency peg. It also provides a natural adjustment mechanism – as Australia’s export prices fluctuate, the currency can move up and down accordingly.

Factors Influencing the AUD

Many different macroeconomic factors impact the valuation of the Australian dollar, including:

Commodity Prices

As a commodity exporter, Australia’s economy relies heavily on mining and agricultural exports. When global commodity prices are high, demand for Australian exports rises, pushing up the value of the AUD. Key exports like iron ore, coal, gold, natural gas and wool drive the Aussie dollar.

Interest Rates

Interest rates set by the RBA influence carry trades and the attractiveness of the AUD. Higher rates compared to other countries make the Aussie more appealing for carry trades, boosting demand. Lower rates have the opposite effect.

Risk Sentiment

When risk appetite is strong, higher-yielding currencies like AUD tend to rise. During periods of market uncertainty and risk aversion, investors sell off growth-correlated currencies like the Aussie and buy safe havens like the US dollar.

Economic Growth

Australia’s economic outlook impacts demand for the AUD. Strong GDP growth and positive economic data tends to boost the currency, while weak data and recessions place downside pressure on the AUD.

Terms of Trade

Australia’s terms of trade measure export prices relative to import prices. Improving terms of trade indicate rising export revenues, which supports the Australian dollar.

Trade Partners

Being part of the Asia-Pacific region, the Australian dollar is heavily correlated with the economic health of its major trade partners – China, Japan, South Korea and others. Fluctuations in these economies and demand for Australian exports impacts the AUD.

AUD and Reserve Bank of Australia Monetary Policy

Australia’s central bank, the Reserve Bank of Australia (RBA), is responsible for conducting monetary policy, regulating the banking system, issuing banknotes, and promoting financial stability and economic prosperity. The bank was established in 1960 and is located in Sydney.

The RBA’s primary objectives are:

  • Maintain price stability and low inflation (2-3% target)
  • Support full employment
  • Promote overall economic growth

The RBA aims to meet these objectives through adjusting the cash rate, which influences broader interest rates and borrowing costs throughout the economy. Lower rates stimulate spending and growth, while higher rates aim to prevent overheating and control inflation.

Monetary Policy Committee

The RBA Board, also known as the Monetary Policy Committee, meets once a month to decide on interest rates. The committee studies developments in international markets along with domestic inflation and output metrics to guide rate decisions. There are nine members on the board, consisting of senior RBA leaders and independent experts.

Tools of Monetary Policy

The RBA has several tools available to impact monetary policy:

  • Official cash rate – Benchmark interest rate that influences bank lending and saving rates
  • Open market operations – Buying and selling government securities to control money supply
  • Term funding facility – Provides cheap long term funding to banks
  • Exchange rate intervention – RBA can intervene in forex markets by buying or selling AUD
  • Macroprudential regulation – Countercyclical capital buffers, loan-to-value measures

Impacts on AUD

RBA policy and interest rates significantly influence the attractiveness of the Australian dollar. Rate hikes typically boost the currency by making AUD assets more appealing for yield-seeking investors. Rate cuts have the opposite effect, reducing yield appeal and driving capital outflows from the Aussie dollar. The RBA also monitors the exchange rate given its impacts on Australian trade competitiveness.

Trading the Australian Dollar

The Australian dollar is one of the most liquid and widely-traded currencies worldwide. Its high volatility and sensitivity to commodities make it popular for forex trading strategies. Here are some tips for trading the Australian dollar:

  • Follow commodity markets closely, as prices strongly influence AUD valuations
  • Monitor Chinese economic data and policy shifts given Australia’s dependence on China trade
  • Watch for divergence between RBA and Fed monetary policies, which impacts AUD-USD flows
  • Be aware of Australia’s terms of trade and exports/imports to gauge Aussie valuation
  • Use risk sentiment proxies like VIX or junk bond spreads to time risk-on/risk-off moves in the AUD
  • Execute carry trades when interest rate differentials favor AUD over funding currencies
  • Utilize technical analysis and look for chart patterns, support/resistance, moving averages
  • Implement stop-losses to contain downside risk when trading this volatile currency
  • Watch for RBA rate decisions, economic data like GDP and employment to anticipate Aussie reactions
  • Consider hedging commodity exposure when trading the Aussie dollar

The Australian dollar provides opportunities for short-term tactical trades around events and data releases, as well as longer-term strategic trades based on commodity trends, risk sentiment, and interest rate differentials. Traders should incorporate both fundamental and technical analysis when trading the AUD crosses.

AUD Trading Pairs

Here are some of the most common currency pairs for trading the Australian dollar:

AUDUSD

The Aussie dollar versus the US dollar is the most liquid AUD cross, trading in both the Asian and North American sessions. As the world’s two largest economies, fundamentals from both Australia and the US drive AUDUSD volatility. Traders focus heavily on the divergence between RBA and Fed policies. Risk sentiment also impacts this pair.

AUDJPY

The Australian dollar Japanese yen pair isolates Aussie strength against the safe haven yen. As a carry trade, it sees large moves based on yield differentials and risk appetite. Strong Chinese data and rising commodities also push AUDJPY higher. The pair tends to be very sensitive to risk sentiment.

AUDNZD

AUDNZD provides exposure to the Aussie dollar against the similarly commodity-driven New Zealand dollar. Also called the Tasman, relative fundamentals between Australia and New Zealand drive price action. It behaves as a risk currency with some sensitivity to China.

AUDCAD

AUDCAD pits the Aussie dollar against the commodity currency of Canada. The pair ebbs and flows based on each country’s exposure to oil, metals, agriculture pricing. Divergence in risk sentiment or growth outlooks between the two economies impacts the cross.

AUDCHF

The relatively high yielding Aussie dollar versus steady Swiss franc makes AUDCHF a popular carry trade. With Switzerland seen as a safe haven, the pair sees large moves driven by risk on/off flows. RBA and SNB rate differentials also impact its valuation.

AUDGBP

AUDGBP measures the Aussie dollar against the British pound sterling. Australia’s trade exposure to China and Asia contrasts with the UK’s alignment to Europe. Relative growth and commodity pricing are key drivers. Risk sentiment also influences price action.

AUDCAD

The Australian dollar against the Chinese yuan provides insight into the Australia-China economic relationship. As Australia’s largest trading partner, Chinese data and commodity demand significantly influence AUDCNY. Yuan strength/weakness can also affect cross valuations.

Key Facts and Figures

Here are some key facts about the Australian dollar as of 2023:

  • Currency code: AUD
  • Issuing central bank: Reserve Bank of Australia
  • Most traded currency pairs: AUDUSD, AUDJPY, AUDNZD, AUDCAD
  • Total banknotes in circulation: $88 billion AUD
  • Banknotes in denomination: $5, $10, $20, $50, $100
  • Most traded banknote: $50 (50% of notes in circulation)
  • Total coins in circulation: $6 billion
  • Coins in denomination: 5c, 10c, 20c, 50c, $1, $2
  • Aussie nickname origins: Reference to the Australian gold rush of the 1850s
  • Global forex trading rank: 5th most traded currency
  • Daily forex turnover: $213 billion USD equivalent
  • Currency regime: Free floating exchange rate
  • Inflation rate: 5.2% year-over-year as of 2023
  • Interest rate: 2.85% RBA cash rate as of 2023

Future Outlook for the Australian Dollar

Looking ahead, strategists expect the Australian dollar to remain volatile in the near future as global markets digest inflationary pressures, rising interest rates and mixed growth signals.

Much depends on commodity prices as a key AUD driver. Strong demand from China should support iron ore and coal exports, but lower prices could weigh on the currency.

Domestically, the RBA is likely to continue raising interest rates to rein in inflation, which should offer underlying support for the Aussie dollar. However, higher rates may also slow economic growth.

Geopolitical tensions represent a wild card for the AUD outlook. Any rise in risk aversion would typically boost safe haven assets and drag down the Australian dollar.

Overall, analysts see the AUD trading in a 0.65 to 0.80 range against the USD over the next 12 months as conflicting fundamentals create two-way price action. Adaptive trading strategies will be required to navigate Aussie volatility.

Conclusion

As a free-floating currency, the Australian dollar provides unique opportunities for forex traders given its sensitivity to commodity prices, China, risk sentiment and interest rate differentials. However, the AUD’s volatility also poses risks which must be managed through disciplined risk management strategies.

By developing a nuanced understanding of what impacts the Aussie dollar, traders can better time entries and exits in AUD crosses. Combining fundamental drivers with technical setups is key to trading the Australian dollar successfully. With its liquidity and volume, the AUD promises to remain a key currency across global forex markets.