Why the AUD is strengthening – and what it means for the mortgages

The Australian dollar is fluctuating, hovering around 80 US cents at the moment. It has gained nearly 5 cents versus the US dollar in February alone. That’s a significant shift for any currency. The Australian dollar is strengthening for a variety of reasons, one of which is linked to the amount you’ll pay on your monthly mortgage payments – may be as soon as later this year.

A stronger economy translates to a stronger dollar

The Australian dollar is a commodities currency, which means that its value fluctuates in relation to other currencies, such as the US dollar. As China speeds up steel production, the price of Australia’s primary export commodity, iron ore, has soared in recent months. It’s presently north of $170 US/tonne, up significantly from roughly $90 US/tonne at this time last year.

At the moment, this is the key driver of the Australian dollar. The arrival of a COVID vaccination in Australia, as well as the implications for consumer and corporate confidence, is also helping to boost the Australian currency. But, more importantly, the economy is improving. The unemployment rate in Australia is decreasing, tens of thousands of new jobs are being created, and little to no coronavirus cases indicate that customers are once again loosening their purse strings (by and large). All of this raises the currency’s value.

The Role of Interest Rates

When a country’s currency appreciates in value, it’s an indication that “things” — aka the economy — are going well. According to the National Australia Bank’s most recent economic growth prediction, this is the case. In a note, senior economist Tony Kelly stated, “We have revised up our prediction for 2021 GDP growth to 5.0 percent and predict the growth of 3.9 percent in 2022.” The economy is now strengthening to the point that financial markets are shifting their expectations of when interest rates would begin to rise up or ahead. David Plank, the ANZ’s Head of Australian Economics, lives and breathes interest rate markets.

For some specialists, this type of positive anticipation might be controversial if we take the covid pandemic into consideration. We cannot say that the pandemic did not affect the country economically and that Australia was best performing in this case. The financial crisis was severe here too that can be seen from several aspects, for example, because of the job shortage and the percentage of people who were desperately trying to find the sources from the financial market to generate some financial profits. Australia is occupying the leading role in the list of countries, where over the last year, the forex and crypto industry was in high demand, and these Australian brokers were trying to make their own clients’ wishes satisfied. We cannot say that this was the way that Aussies survived the economic crisis, but we can say that it played an important role in terms of additional sources of income.

He claims that, despite the Reserve Bank’s promise that interest rates would not be raised until 2024 at the earliest, financial markets are wagering that they would be raised sooner. Mr. Plank replies, “The market is permitted to do that; it’s all about trying to predict what will happen in the future.”

The RBA’s vow to keep the cash rate where it is is an expectation, not a promise. So, if the data performs significantly better than projected, the cash rate may rise before 2024.

RBA Actions

Markets have a tendency to fire first and ask questions later. The three-year Australian government bond’s interest rate began to climb earlier this week. Money markets are looking forward and saying to themselves, “I believe interest rates will be higher in three years than they are now.” The RBA is aware of this and is concerned. It has previously said that it will remain in the market buying bonds (down bond yields) to ensure that interest rates on such bonds (of any maturity) do not rise until at least 2024.

As a result, when the three-year bond rate increased, the RBA stepped into the market and purchased $1 billion in three-year government bonds (to lower the yield). But here’s the thing: the market saw this action as the Reserve Bank not being serious about keeping the interest rate on the three-year bond under control. Even a whiff of a better return draws investors from all over the world, so when the Australian dollar’s interest rate jumped, speculators bought it up to profit from the market movement.

Interest rates are expected to rise as the Australian dollar rises

As a result, the Australian dollar is gaining since the economy is growing, commodity prices are rising, and there is a possibility that Australian interest rates may rise much higher. Furthermore, worldwide traders, not just local money market dealers, are doubting the Australian Reserve Bank’s commitment to keeping interest rates low. If you have a fixed-rate mortgage, this is important.

According to David Plank of ANZ Bank, three-year fixed rates would fluctuate depending on changes in the three-year government rate and the Reserve Bank’s Term Funding Facility or TFF (which is also facilitating ultra-cheap commercial bank funding). The location of market rates has an impact on fixed rates. However, with fixed rates, the TFF is the most important factor. The TFF serves as an anchor for three-year funding costs, thereby determining the three-year mortgage rate.

The prognosis is still bleak

The Australian dollar is expected to trade as high as 82 US cents by the end of the year, according to analysts at ANZ Bank and the Commonwealth Bank. This is a sign that they expect the economy to improve further. It’s also a sign that Australian interest rates will continue to climb (albeit not necessarily the overnight cash rate).

This may frighten home purchasers who have pushed their financial limits; it may also delight property aspirants who can afford a higher rate of interest but are keen for house prices to fall.

 

Image courtesy of TheMoneyMan/YouTube

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