AUD to USD: Australian Dollar to Stay Low

AUD to USD Exchange Rate DownThe AUD to USD exchange rate declined quite a bit over the past year. On July 1st of 2014, one Australian dollar could get you $0.949; today, it can only get you $0.775. Based on macroeconomic conditions, I expect this trend to continue. That is, the Australian dollar will further depreciate against the mighty U.S. greenback.

Upward Pressure on USD

Several things are pushing up the greenback these days.

The U.S. labor market has been recovering. In the most recent labor market report, the U.S. Bureau of Labor Statistics reported a total of 280,000 jobs added in May, after 221,000 jobs added in April. Average hourly earnings also increased to $24.96 in May; that’s 2.3% year-over-year. The unemployment rate was as low as 5.5%, a number envied by many countries with serious unemployment issues.

Existing home sales showed that the U.S. housing market has improved. For the month of May, existing home sales came in at an annualized rate of 5.35 million units—the highest since November 2009. This is a 5.1% increase from April’s 5.09 million, and an impressive 9.2% gain year-over-year. The U.S. existing home sales have been increasing year-over-year for eight consecutive months. The outlook was also positive—the chief economist at the National Association of Realtors said that without substantial construction of new homes, housing prices are likely to stay elevated, even when mortgage rates go above four percent.

Over the past several months, analysts have been pondering over U.S. gross domestic product (GDP) numbers in Q1 2015. In April, the Bureau of Economic Analysis (BEA) reported its first estimate of a 0.2% increase. One month later, the number was revised to a 0.7% decline. Yesterday, the third and final estimate showed a 0.2% decline, suggesting the U.S. economy contracted less than expected.

Downward Pressure on AUD

Pressure on the Australian dollar will be taking presence soon.

Part of the downward pressure on the Australian dollar comes from China, Australia’s largest trading partner. The Chinese economy is showing signs of weakness nowadays. In May, China’s exports declined 2.8% year-over-year, after a 6.2% drop in April and a staggering 14.6% drop in March. Imports slipped a dramatic 18.1% in May and 16.2% in April.

Manufacturing wasn’t a help, either. The Purchasing Manager’s Index (PMI) has been below 50 for three consecutive months. This indicates that the manufacturing sector in China has been contracting.

China’s slowdown will likely be felt around the world. One country of severe impact could be Australia, who has been selling iron ore, coal, and other minerals to China in huge quantities. The slowdown in construction in China could imply less demand for Australia’s iron ore, while the new regulations on the burning of coal in major cities would impact its demand for coal. However you look at it, Australia is going to be affected by China’s slowdown, as one-third of its exports go to the country.

The declining price of iron ore and other commodities will also affect the value of the Australian dollar in a negative way. Last June, iron ore fines were trading at more than $90.00 per ton. Fast forward 12 months and they are trading at just above $60.00 per ton. If prices of iron ore and other minerals continue to go south, expect further depreciation of the Aussie dollar.

Another downward pressure of the AUD-USD pair could be from the central banks. Over the past few decades, growth has been solid for Australia. However, the recent economic climate, affected by China’s slowdown and the uncertainty in Europe, suggests that Australia’s future growth path may be flatter than expected. The Reserve Bank of Australia, the nation’s central bank, will likely lower interest rates in response to slowing down growth. The Federal Reserve in the U.S. is expecting two rate hikes in the remainder of this year. Putting all this together, we have interest rates declining in Australia but rising in the U.S. When this happens, expect the AUD-USD exchange rate to fall.