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Are Interest Rate Differentials Starting to Dictate the Australian Dollar Level?

Mar 08, 2018

Are interest rate differentials finally starting to dictate the AUD$/USD$ pair? While United States macroeconomic prospects have improved over the past couple of months, the USD$ has weakened against major G10 pairs. The USD$ weakness is surprising given that the macroeconomic improvements should warrant an appreciation in the USD$. Nonetheless, an opportunity to short the AUD/USD certainly looks attractive.

Common arguments for USD$ weakness across G10 pairs are political uncertainty, a focus on twin deficits, and attractiveness in emerging markets due to synchronous global economic growth. Although the AUD$/USD$ short has fared well since the end of January, the USD$ has yet to reach levels against the AUD$ as it had in early December.

The case for further depreciation of the AUD$ is built on the fact that interest rate differentials for AUD$/USD$ are negative and are expected to widen further. Australia’s economic growth and velocity of money are decelerating, which does not support a hawkish policy by the Reserve Bank of Australia. These key points, coupled with the improvement in the United States’ economy, should lead to an attractive trade in the short-term.