Australian Dollar trades higher despite Mideast war-led cautious market mood
- The Australian Dollar gains on hopes wider policy divergence between the RBA and other central banks.
- The RBA is expected to raise interest rates again in May.
- Peace mediators dismissal to Trump’s claim that strikes on Iran were paused on Tehran’s request has revived risk-off impulse.
The Australian Dollar (AUD) outperforms its major currency peers, trading marginally higher to near 0.6900 against the US Dollar (USD) during the late European trading session on Friday. The antipodean trades higher even as the market sentiment remains risk-averse due to hopes of de-escalation in the Middle East easing.
During the press time, S&P 500 futures are down 0.4% to near 6,450, indicating a risk-off market sentiment. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, trades 0.2% higher to near 100.00.
The Australian currency gains on expectations that the pace of monetary policy tightening by the Reserve Bank of Australia (RBA) would be faster than other major central banks, as inflation in the Australian region was high even before the war in the Middle East started. According to a Reuters report, markets imply a 68% chance of a May hike and see rates reaching 4.75% by year-end.
Meanwhile, easing hopes of de-escalation in the Middle East war have underpinned the risk-off impulse. Conflicting statements by peace mediators against United States (US) President Donald Trump’s claim that the 10-day pause to planned military strikes on Iran’s power plants was requested by Iran have revived fears of a prolong Middle East war.
According to a report from the Wall Street Journal (WSJ), peace talks mediators have dismissed claims that Iran had requested a 10-day pause on strikes on its energy plants.
RBA FAQs
The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a board of governors at 11 meetings a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.
While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.
Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.
Quantitative Easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) for the purpose of buying assets – usually government or corporate bonds – from financial institutions, thereby providing them with much-needed liquidity. QE usually results in a weaker AUD.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.
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