Global markets experienced heightened volatility in 2020, a profound characteristic that also had a material effect on movements in the Australian Dollar.
When compared with the US Dollar, commonly considered as the benchmark comparitive currency, the AUD reached 15 year lows of 1AUD per 50.49 US cents during the March market sell off in 2020. The capital flight saw a sharp decline of over 10% in the AUD over a 2 week period. Proceeding this, the AUD has rallied, appreciating 57.7% since March lows on the back of a number of catalysts and drivers.
In this two-part series, we look at the catalysts which have caused the AUD to appreciate despite measures which have attempted to keep the AUD stable against the USD. This part looks at these measures and the first two drivers, while the next part looks at the remaining three drivers, drivers which will continue to impact the Australian dollar in 2021.
AUD Fighting Bearish Drivers
Despite the record low cash rate of 0.1% in 2020 and quantitative easing measures to the tune of $100 billion to buy government bonds, the Australian dollar has steadily appreciated against the USD. Through an interest rate differential lens, having a lower cash rate than the US who are at 0.25% has not deterred investors from Australian assets despite fixed income being priced higher and consequent lower returns.
In tandem, the AUD has offset the effect of Australia’s first ever quantitative easing spending which, all other things being equal, should reduce the value of the currency via an increase in supply of the dollar. However, despite this downward pressure, several bullish drivers have offset bearish dynamics prevalent in the Australian economy.
Driver 1 – Iron Ore Prices
Iron ore, being Australia’s largest export, has driven demand for Australian dollars and in turn led the appreciation of the AUD. After rising by 72.3% in 2020, iron ore continued to perform in the new year. Rising from US$90/t to US$158.5/t in 2020, the rise underlines the material tailwinds catalysed by Chinese demand and global supply shortages. These two factors have continued to drive iron ore prices in the new year, pushing iron ore back up to 2020 highs of US$171.50/t, and into a fresh breakout towards US$174.0/t.
Iron Ore Demand Factors
China’s infrastructure led fiscal stimulus has led to increased demand for steel and iron ore. As the leading consumer of iron ore at 57% of global imports, their steel-based projects will continue to require iron ore to build the rail, airports, bridges, and ports at hand. Consequently, 2021 has so far seen iron ore remain at 8-year highs beyond US$150/t (apart from a single day dip to $148.5 in early February), despite Chinese fiscal stimulus outside of its standard budget reducing.
China has unveiled the 14th “Five-year Plan” where infrastructure projects are expected to be focused on six main areas: 5G networks, industrial internet, transport, data centres, AI and new energy vehicle charging stations. This is budgeted to total 2tn yuan of public investment per year for 5 year (10tn total by 2025).
Market commentators cite research suggesting China has the highest multiplier of all developed economies sitting at 3, meaning that these investments effectively have a threefold multiplied effect on economic growth, proving to be an attractive investment program for the PRC (People’s Republic of China), moving through the next few years. The 10tn package represents 10% of China’s GDP in 2019, exemplifying the size of this investment and the tailwinds present in the iron ore space.
Despite these investment budgets, geopolitical tensions are rising between China and Australia, two of the largest players in this space, which could represent potential headwinds to the existent role this trade relationship has on a rising AUD. Albeit during a time of significant tension, the expectation is that these tariffs will not be implemented on Australian iron ore due to China’s inability to supply their own demand and dependence on the Australian pipeline.
Iron Ore Supply Factors
On the supply front, Brazil’s reduced capacity has driven lower supply iron ore supply in global markets. On the back of the Brumadinho dam disaster, which killed 260 people and led to the closure of several mines (owned by Vale and BHP), in Brazil for due diligence investigations, supply of iron ore in global markets fell by 20%.
Subdued supply levels stemming from Brazil’s regulatory oversight has put upward pressure on iron ore prices on the supply front. However, analysts expect that Vale, the world’s biggest iron ore producer will finally expand their production levels, after settling some cases and passing regulatory criteria. Vale returning to full production will increase supply in global markets which should see iron ore prices normalise towards the end of 2021.
Driver 2 – Australian Export Sales
Australia has experienced material tailwinds in mineral exports which have in turn put upward pressure on the Australian dollar.
This feat can be recognised through quantified analysis of Australia’s balance of trade which experienced its best month on record being $9.7 in the black along with Q2 inflows at a high of $22.5B. Compounded with this, Australia’s current account balance has been in surplus for FY20, this is the first time this has occurred in 45 years. This highlights how there were more inflows of capital in the form of financial and trade flows into Australia and accounts for AUD appreciation.