Since establishing a market bottom in the beginning of March, the Australian dollar has been ripping higher through every price level. First breaking above 0.7900, then 0.8100 and now it is trading at 16 year highs above 0.8400. What can possibly be fueling the rally? In two words, interest rates.

As always has been the case, higher interest rates help to fuel a currency’s momentum and the Australian dollar is no different. Offering the one of the highest rates in the industrialized world the nation’s central bank, the Reserve Bank of Australia, have increased rates to 6.25 percent, leaving rates steady as of the most recent decision. The rate notion becomes particularly important when factoring in the idea of the recently glamorized carry trade. Paired against lower yielding pairs like the Japanese Yen, investors are able to get their cake and eat it too: interest earnings on the rate differential and the spot price appreciation. As always though, there is the concern that whatever comes up, must come down. That’s true, but right now buying power looks to be on the side of the Australian dollar bull.



Fundamentally Speaking

There’s plenty of interest in the Australian dollar, and not just on the carry trade side. As with any other asset: if there’s solid fundamentals, they will come. The currency has advanced the strongest in 18 years as growth remains healthy and supported in comparison to global trade partners. According to the most recent report by the Bureau of Statistics in Sydney, gross domestic product rose at a healthy 1.6 percent in the first three months of the year, propping up the annualized comparison to 3.8 percent and almost tripling that of the US economy. Attributed to the acceleration in growth has been supported consumer and business confidence as productivity has spurred the lowest employment rate in 32 years in the month of April. This in turn has helped to churn wage costs higher, giving shoppers more bang for their buck. As a result, with appreciating momentum still likely in the cards for the country, the evidence should add to rising valuations in the underlying spot price. The notion is also being helped by current market sentiment that continues to see one more rate hike by Central Bank Governor Stevens & Co. in the third quarter. Higher wages tend to lead to mounting rates of inflation which is still a top priority for the country’s monetary authorities. With current inflation still running at the top end of the current benchmark target, it remains highly likely that short term lending rates will continue to rise above the 6.25 percent. Future expectations support the notion with implied contracts expectant of another 25 basis point rate hike by September of this year. As mentioned before, should rates of return rise, the idea will add considerably to the favoritism of the currency.

What’s In Store?

With fundamentals in mind, things still remain optimistic for the underlying spot appreciating. Manufacturing looks to continue, helping to support employment and subsequent domestic spending in the country. The only caveat it seems is the fact that the higher valued currency may crimp global exports in the longer term. The notion should be minimized, however, when taking into account the immense focus being placed on the carry value in the short term. On the other side, technically speaking, the pair looks bullish as well. The underlying currency has broken through key resistance at the 0.8000 figure, the impetus for the recent 300 pip push higher. However, with the short term a little overextended, a slight decline can be expected on consolidation, as mentioned in the most recent DailyFX Technical Report. The spark here, fundamentally, seems to be the upcoming employment report set for release in the overnight session. With less than stellar results expected, and addition of a mere 11k, the report’s findings could be a short term shot in the arm and trump current momentum instilled in the market.



Richard Lee is a Currency Strategist at FXCM.