The Australian dollar is on the move, now hovering around 80 US cents.
Over February alone it’s gained roughly 5 cents against the US dollar. That’s quite a move for any currency.
The Australian dollar is increasing in value for several reasons, and one of those reasons is also tied to how much you’ll be paying on your monthly mortgage repayments — potentially as soon as later this year.
Before we look at that link, let’s explore what’s pushing the dollar higher.
A stronger economy means a higher dollar
The Australian dollar is what’s called a commodities currency, meaning its value against the US dollar, for example, rises and falls as commodities prices move.
The price of Australia’s biggest export commodity, iron ore, has been roaring ahead in recent months as China ramps up steel production.
It’s currently north of $170 US/tonne — an enormous increase on where it was this time last year at around $90 US/tonne.
This is the main driver of the Australian dollar at present.
The arrival of a COVID vaccine in Australia, and what that means for consumer and business confidence, is also pushing the Australian dollar higher.
More than that, though, the economy is improving.
Australia’s unemployment rate is falling, tens of thousands of jobs are being created, and low to no coronavirus case numbers mean shoppers are once again loosening their purse strings (by and large).
We’re not out of the woods yet, but we’re moving out of recession, not into one.
This all pushes the currency higher.
Interest rates playing a role too
A basic rule of thumb is that when a country’s currency rises in value, it’s a sign “things” — aka the economy — are going well.
The National Australia Bank’s latest economic growth forecast points to this.
“We have revised up our forecast for 2021 GDP growth to 5.0 per cent (previously 4.5 per cent) and expect growth of 3.9 per cent in 2022,” senior economist Tony Kelly wrote in a note.
The economy’s improving enough now to prompt financial markets to shift up or move forward their expectations of when interest rates will start rising.
The ANZ’s Head of Australian Economics, David Plank, watches interest rate markets for a living.
He says despite the Reserve Bank’s statement that it would not raise interest rates until 2024 at the earliest, financial markets are betting they will go higher earlier than that.
“The market is allowed to do that, it’s all about trying to assess what’s going to happen in the future,” Mr Plank says.
“The RBA’s commitment about the cash rate staying where it is an expectation, it’s not a pledge.
“So, if the data does do much much better than expected, maybe the cash rate will rise before 2024.”
RBA fought and lost
Financial markets tend to shoot first and ask questions later.
Earlier this week, the interest rate on the three-year Australian government bond began to rise.
Money markets are looking at the outlook and literally thinking, “I think interest rates will be higher than they currently are in three years’ time”.
The RBA knows this and has become concerned.
It has in the past signalled it’ll be in the market buying up bonds (which lowers the yield on bonds) making sure interest rates on those bonds (of any maturity) don’t rise until at least 2024.
So, naturally, when the rate on the three-year bond rose, the RBA went into the market and bought $1 billion worth of three-year government bonds (to lower the yield).
Here’s the thing, though: the market viewed this move as the Reserve Bank not being particularly serious about keeping a lid on the interest rate on the three-year bond.
“The RBA really needed to [buy more] to emphasise its determination to make that bond trade where it wants to,” Mr Plank says.
In response, the RBA’s move actually prompted a sell-off in the three-year government bond market and, as you can see below, that produced a lift — albeit a very small one — in the interest rate.
Even a sniff of a higher return attracts investors from all around the world, so when this interest rate rose, investors bought up the Australian dollar to take advantage of the market movement.
A rising Australian dollar points to rising interest rates
So the Australian dollar is rising because the economy is improving, commodities prices are rising, and there’s a hint Australian interest rates could be rising higher.
Even more than this, global traders — not just local money market dealers — are questioning the Reserve Bank’s resolve to keep a lid on interest rates.
This matters if you have a fixed rate mortgage.
The ANZ Bank’s David Plank says three-year fixed rates will change based on movements in the rate of the three-year government, and the Reserve Bank’s Term Funding Facility or TFF (which is also facilitating ultra-cheap commercial bank funding).
“Fixed rates are influenced by where market rates are,” Mr Plank says. “The key there, though, for fixed rates is really the TFF.
“The TFF is an anchoring point for the cost of funding for three years and so that is really setting the three-year mortgage rate.
“So when the TFF [ends], which the RBA has signalled could happen at the end of June, I would expect to see fixed rate mortgages rise as a consequence of that.”
The outlook remains uncertain
Analysts at the ANZ Bank and the Commonwealth Bank expect the Australian dollar to trade as high as 82 US cents by the end of the year.
That’s an indicator they expect the economy to continue improving.
It’s also an indicator that Australians’ interest rates (not necessarily the overnight cash rate) will continue to rise.
This might worry those home buyers who have stretched themselves to the limit financially; it may also excite property hopefuls who can afford to finance at a higher rate but are desperate for house prices to come down.
As for overseas travellers who would normally benefit from a rising Australian dollar: What can I say? It’s frustrating, isn’t it?