The United States Dollar (USD) and the Australian Dollar (AUD) are two of the most sought-after currency trading pairs in the global foreign exchange (forex) market.
According to Bloomberg, the Australian Dollar (or the Aussie as it’s colloquially known) has maintained reasonable stability against the greenback in the past few weeks, topping out at 1.52 for 1 USD.
But like any new forex investor, it’s imperative to understand the dynamics affecting the USD-AUD relationship to max out on this currency pair.
Read below as we share invaluable insights into AUD/USD trading.
Tracing the AUD/USD Relationship
To understand the current Australian Dollar vs US Dollar exchange rates and the factors affecting the currency pair’s relationship, it’s prudent to start from where it all began.
Australia initially used the Australian Pound as its official currency. The pound was pegged on the Sterling.
However, the Sterling’s value dived its dramatic devaluation in 1931, heralding the birth of the Australian Dollar.
Australia formally adopted the dollar in the 1960s. The AUD achieved tremendous stability over the years, gaining against many dollar-based currencies.
Factors Influencing the AUD/USD Relationship
1. Favorable Balance of Trade
Australia maintains excellent trade relations with many countries, including China and several Western nations. The Australia-China bilateral partnership, in which the former has historically enjoyed a remarkable trade surplus, is mostly credited for propping up the AUD over the years.
Australia is also a leading trade partner of the United States. The country is immensely endowed with natural resources and has been a major coal and iron ore exporter to the US. Recent estimates indicate that up to one-quarter of Australia’s inward foreign investment (approximately AUD 1.09 trillion) comes from the United States.
In 2005, the Australia-United States Free Trade Agreement (AUSFTA) took effect, bolstering an already healthy partnership between the two nations. Since this historic trade agreement was normalized, Australia has registered over 90% increase in the importation of US goods.
2. International Demand
The AUD-USD is the fifth most-traded currency pair in the forex market, a spot it has maintained for years. The consistent demand for the Aussie has also significantly impacted its relationship with the greenback.
But how does that demand come about?
When Australian traders export goods or services to the United States, the overseas buyers purchase their merchandise in Australian dollars. This increases the average demand for the AUD, raising its value against the USD.
The same dynamics come into play when Australians import goods from the United States. Each importation means a trader must exchange their AUD for the USD, allowing them to pay for the merchandise in the importer’s currency.
3. Interest Rate Differential
An interest rate differential (IRD) is the difference between the interest rates levied on two similar interest-applicable assets. In this case, the assets are the Australian Dollar and the United States Dollar.
The interest rates applicable to the AUD and USD are set by their relevant federal reserves – the Reserve Bank of Australia and the US Federal Reserve, respectively.
Both federal reserves review their interest rates regularly, impacting how the AUD performs against the USD. An upward review of the interest rates would result in the weakening of the currency and vice versa.
Inflation is one of the reasons federal reserves review interest rates. The Aussie’s exchange rate would undoubtedly plummet if inflation rates skyrocket in Australia compared to the United States.
Strategies for Trading the AUD/USD Pair
1. The Carry Trade Strategy
The carry trade strategy leverages the interest rate differentials between the Australian and US Dollar. It tracks the interest rate reviews by both the Reserve Bank of Australia and the US Federal Reserve.
Remember that reviewing the interest rates of either currency upwards diminishes its demand, and vice versa.
However, it’s essential to track interest rate differentials over several months before invoking the carry trade strategy.
2. The Range Trading Strategy
Like most currency pairs, the AUD/USD has a specific price range that fluctuates. Understanding this range can be instrumental in determining when to trade the pair.
For instance, you might consider importing goods and paying them in US Dollars when the AUD/USD exchange rate favors the AUD.
The range trading strategy requires patience in tracking the AUD/USD entry and exit points. Pay particular attention to when the currencies oscillate beyond their prevailing trading equilibrium.
3. The Volatility Breakout Strategy
The volatility breakout strategy entails identifying key support and resistance levels of the AUD/USD pair.
The support level is at which the demand for a currency on an upward trend is expected to pick up. It differs from the resistance level, which denotes the point at which the demand for a currency on an upward trajectory will likely pause.
Support and resistance levels are both impacted by forex market volatility. An increase in volatility signals a likely continuation of a trend.
Now, assume that the USD has been shedding against the AUD and that the market has become even more volatile. In that case, hoarding your AUD may be an excellent idea until the currency hits its resistance levels.
Summary
The AUD/USD currency pair is one of the go-to options for many forex investors. Despite the various dynamics affecting AUD-USD exchange rates, it’s great to know that you can still implement certain strategies to profitably trade this currency pair.