As China and the US inch closer to war in the Asia Pacific, the Australian Dollar is holding firm at about two US cents against the Australian Dollar. This is the biggest strength in Australia’s currency since September 2020. In fact, the Australian Dollar is now stronger than the Euro. Is this a sign of a stronger Aussie economy that could make a move in US Dollar territory in the future?
As noted above, Chinese officials are hinting that China might not follow through with its promise to intervene in the Asian currency market, especially if the United States and Japan decide to increase their military presence. The implication is that China might wait until after a major political event, such as an election or an economic slowdown, before making its moves. It is also possible that China is bluffing in order to avoid a trade war, and the move may be a prelude to one.
If China does not intervene on the currency market, this may signal a stronger Australian Dollar that may soon outpace its US dollar counterpart. However, if China does, the result will likely be more US dollar strength. A stronger US dollar may even make the Australian Dollar more attractive to investors.
If there are no developments from China, then a weak US dollar is not a bad thing for Australia, as it would provide more buyers for its exports. Furthermore, with the US dollar falling so far, it would also make Australia’s exports more competitive in overseas markets. A stronger dollar may even encourage more domestic spending, which would create additional pressure to reduce household debt.
But China may be signaling more than just waiting for the US and Japanese to make their move. If China is willing to let the US Dollar drop below current levels, it may indicate that China has decided to slow down the economy in order to prevent the US Dollar from strengthening. Since the Australian Dollar currently is around three to four percent above US dollar levels, China’s announcement could push the Australian Dollar lower by up to around one percent or so in the next few months.
If China does allow the US Dollar to break the EUR/USD 1.30 level, the resulting appreciation could push the Euro lower. in the opposite direction. It would likely take at least one year for the EUR/USD to regain this level, especially if China does not intervene in the currency market.
It is also possible that China is waiting for other countries to react to its intervention. if the United States and Japan decide to hike rates, the US Dollar will likely follow suit, and the weaker Aussie Dollar would probably strengthen. As a result, the Australian Dollar could fall further into a US Dollar strength trap.
On the other hand, if China does not intervene and the US and Japanese don’t announce a new round of easing, the Australian Dollar will likely continue its current trend upward and reach or surpass its current EUR/USD value within the next six months. This could push the Australian Dollar above and past EUR/USD 1.35 level in less than two years. At that point, the Australian Dollar would no longer be under any pressure.
With that said, if the Australian Dollar was to surpass the EUR/USD 1.35 level and stay there, it would suggest that the RBA was not expecting any further moves upward in the Australian Dollar, which means the Australian dollar could fall back to EUR/USD 1.30 level after the US Federal Reserve hikes its interest rates. If the RBA did not expect that the Australian Dollar would remain above EUR/USD 1.35 level, the Reserve Bank of Australia (ARB) may continue its massive buyback program and possibly even raise the base rate.
If the RBA does not intervene and the Australian Dollar falls below the EUR/USD 1.30 level, it would mean that the RBA is simply waiting for another big move in the US Dollar, and not expecting further moves higher in the AUD. The Reserve Bank of Australia has been buying up the country’s largest companies in the hope that the AUD will rebound as its balance sheet improves. At that point, it would probably hike the base rate and the Australian Dollar would likely fall further.
It’s important to remember that the Reserve Bank of Australia (ARB) is one of the most powerful central banks in the world and, unlike the Federal Reserve, it makes decisions based on economic data, not political pressures. It has a lot more power to control the Australian Dollar than the Federal Reserve, since the Australian Dollar trades more heavily than most other major currencies.