The Australian dollar has cemented its position as one of the best-performing currencies this year as surging commodity prices and the rising interest rate environment combine to propel the local currency higher.
The Australian dollar finished the week above US74¢ for the first time in 2022, rising 0.5 per cent against the greenback to US74.15¢ in New York on Friday (Saturday AEDT).
The currency is up 2 per cent this year, which is the largest gain of the Group of 10 currencies – the most heavily traded and liquid currencies in the world.
It was fetching US74.18¢ after midday (AEDT) on Monday.
The rally has been underwritten by sharp price increases in commodities, including those exported by Australia, with iron ore back above $US150 a tonne and oil sitting above $US100 a barrel.
The beginning of a tightening cycle by the US Federal Reserve has also historically penalised the greenback and favoured the Australian dollar.
The Australian dollar has appreciated in six of the past seven Fed cycles, according to Commonwealth Bank analysis, not including last week’s interest rate rise which was the first for the US economy since 2018.
“It seems the market is taking a very glass half-full approach to the Aussie dollar,” said Ray Attrill, head of FX strategy at National Australia Bank.
“The rally boils down to the support Australia is getting for its terms of trade from elevated commodity prices outweighing whatever negative impact is coming through from risk sentiment relating to the outbreak of war, and the ratcheting up of US interest rates.”
The local currency has also benefited from a short squeeze, with data released on Friday by the International Monetary Market revealing a significant reduction in speculative short positions, particularly among leveraged investors such as hedge funds.
Traders shorted the Australian dollar as a hedge against deteriorating risk sentiment in the lead-up to Russia’s invasion of Ukraine, but the currency’s resilience has forced them into buying to cover those positions, adding fresh momentum to its advance.
“Evidently, some of those betting on the Aussie inevitably being one of the main currency market casualties of Russia’s invasion of Ukraine have been forced to run for cover,” Mr Attrill said.
Another boost for the Australian dollar was the greenback dropping almost 1 per cent last week as the Fed acted on its pledge to increase the funds rate. The US dollar historically rises leading into the start of a cycle, and then weakens.
Bond traders expect the Reserve Bank of Australia to join the global monetary tightening cycle at the June meeting, revised forward last week from July because of Australia’s 4 per cent jobless rate, which is the lowest in 14 years.
Commonwealth Bank strategists observed that implied volatility across currencies, bonds and equities has eased back below levels before Russia’s invasion of Ukraine.
“The question for this week is how high the dollar can go,” said Joseph Capurso, head of international economics at Commonwealth Bank.
“The war aside, the fundamentals suggest to us the next big move in the Australian dollar is up … [it] almost always increases when the US Federal Open Market Committee is increasing the funds rate and volatility in financial markets is easing.”
Westpac strategists remain surprised by the speed of the currency’s recovery.
While acknowledging the factors that have supported the Australian dollar’s rise, they noted the war between Russia and Ukraine would hit European and global growth, which isn’t a positive backdrop for pro-cyclical assets such as the Australian dollar.
Westpac therefore sees the Australian dollar’s March 7 intraday high of US74.41¢ capping its move in the near term.