Imagine shorting the Australian dollar on huge leverage last year… You could have made big money. The AUD to USD exchange rate went down more than 10% in 2015!
That’s a massive move for such a major currency pair. But wait, the move might not be over just yet. There are quite a few catalysts that could sink the Australian dollar even lower against the mighty greenback in 2016.
Let me explain.
This Is Bad News for the Australian Dollar
International trade and exchange rates have strong connections. When you buy something from another country, you might need to settle the deal in their currency. If you buy more from your trading partner, the quantity demanded for their currency goes up.
Australia has a substantial export sector. However, this time around, its trading partner might not be able to help the Aussie dollar.
Yep, I’m talking about China—which happens to be Australia’s biggest trading partner. In fact, 28.3% of Australia’s exports have been going to China. (Source: “Australia’s Trade in Goods and Services 2014-2015,” Department of Foreign Affairs and Trade,
November 25, 2015.)
Economic growth has been slowing down in the country that used to be the manufacturer of the world. Gone are the days of double-digit growth in China’s gross domestic product (GDP). In the most recent quarter, the Chinese economy grew at an annual rate of 6.8%. (Source: “China GDP Annual Growth Rate,” Trading Economics, last accessed February 1, 2016.)
One factor that could impact the Australian dollar is China’s shrinking manufacturing sector. The Caixin Manufacturing Purchasing Manager’s Index (PMI) came in at 48.4 in January 2016. Numbers below 50 indicate contraction in China’s manufacturing economy. Moreover, January marked the 11th successive month in which the index was below the 50-point barrier. (Source: “Caixin China General Manufacturing PMI,” Markit Economics, February 1, 2016.)
Note that iron ore is Australia’s top export. As China’s manufacturing sector slows down, it could demand less iron ore from Australia. In fact, this might have already happened. In 2013–2014, Australia exported $74.7 billion worth (in Australian dollars) of iron ore and concentrates. In 2014–2015, the number declined to AU$54.5 billion. That was a more than 27% drop!
Exports also make up a significant part of Australia’s economy. According to data from the World Bank, Australia’s exports of goods and services represented more than 20% of the country’s GDP. Therefore, a slowdown in China’s economic growth could not only weaken the Australian dollar, but also send waves through Australia’s economic output as well. (Source: “Exports of Goods and Services as Percentage of GDP,” The World Bank, last accessed February 1, 2016.)
Rate Cut Coming Soon?
For those who think the Australian dollar could make a comeback since the U.S. Federal Reserve had a cautious tone in its January meeting, think again. Sure, the Fed did not raise rates in January, but look what it did the month before. In December 2015, the Fed increased its benchmark interest rate by 25 basis points, marking the first rate hike since the financial crisis.
Moreover, although the Fed has expressed concerns about weak economic growth around the globe, its plan to gradually increase interest rates hasn’t changed. Some analysts are saying that the next rate hike could come as early as March.
“I still think they are going to raise rates in March,” said Gus Faucher, a senior economist at PNC Bank. “I don’t want to oversell it, but I think that while what goes on overseas has an impact on the U.S. economy, what’s much more important is what goes on domestically.” (Source: “A January Pause, but Fed Affirms Plan for Gradual Rate Increases,” The New York Times, January 27, 2016.)
The Reserve Bank of Australia (RBA), the nation’s central bank, is about to release its rate statement. The central bank is expected to keep the benchmark interest rate unchanged at two percent. However, with headwinds blowing strong in the Australian economy, the RBA might have to cut rates down the line to boost the economy.
Imagine what would happen to the AUD/USD pair when the Fed raises rates again, while the RBA is cutting them.
The bottom line is this: the worst is not over for the AUD to USD exchange rate. The worst is yet to come.