AUD/USD remained buoyant over the first half of 2021, largely trading in a 0.7560 to 0.7850 range. The high in AUD occurred in late February 2021 when AUD/USD briefly lifted above 0.8000. Resilience in AUD/USD over the first half of 2021 was largely encouraged by a rise in base metal prices and iron ore prices, as the global economy continued to recover from the initial March 2020 pandemic shock.
However, over the second half of 2021, AUD began to depreciate. Iron ore prices started to fall after lifting to more than US$225 a tonne, and by October, base metal prices were declining too. Adding downward pressure to commodity prices and AUD/USD was the fact that the USD began to strengthen in mid-2021. The USD began to rise as U.S. inflation pressures accelerated, and markets started to factor in the prospect of a Fed tapering in late 2021, and a lift in the Fed funds rate in 2022 (see chart).
Adding downward pressure to AUD/USD over the second half of 2021 was the softening in the Australian economy and the decline in the Australian three-year bond yield, as the Australian state governments re-imposed covid-related government lockdowns.
The ending of harsh covid-related government lockdowns in early Q4 drove a bounce-back in the Australian economy. Higher than expected Australian Q3 inflation added fuel to the view that the Reserve Bank of Australia (RBA) would discontinue the target of 10 basis points (0.10%) for the three-year (April 2024) Australian Government bond yield. The RBA subsequently decided to end this policy at its 2 November board meeting.
However, market participants were disappointed that the RBA didn’t go further and discontinue its $4 billion per week asset purchases of government securities in response to the acceleration in the Australian economy. The RBA took the view that core (trimmed mean) inflation at 2.1% in Australia was still relatively low, and that it was not necessary to reduce the rate of monetary stimulus in the Australian economy. The dovish stance by the RBA applied downward pressure to AUD/USD, as the Australian three-year bond yield began to decline, following its spike prior to the November 2 RBA board meeting (see chart).
Downward pressure on AUD/USD was also applied over the second half of 2021 as speculators began to short AUD/USD. The combination of a slowing global economy, and the factors described above including a strengthening USD, generated a large accumulation of speculator’s short positions on AUD/USD to multi-year levels (see chart).
Observing the overall performance of AUD 2021, it was notable that AUD weakened against most of the major currencies, except against EUR and JPY. The 2021 depreciation in AUD/USD was only exceeded by the depreciation in AUD/CNY (see chart).
The outlook for 2022 is blurred by the risk that government-induced covid-related lockdowns being re-introduced across Europe in late 2021, could occur in Australia because of the spread of the omicron variant. The likelihood that the global economy softens as a result of Europe’s government lockdown measures will limit near-term upside in AUD/USD because of AUD’s sensitivity to the strength of global economic growth.
History has shown if similar lockdown measures are re-introduced into Australia, then AUD/USD will depreciate. However, if no lockdown measures are re-introduced by the Australian government, then we could see AUD/USD trade higher over 2022.
A decision by the RBA to end, or taper, asset purchases, possibly as soon as February 2022, will support strength in AUD/USD. Once the RBA moves down this path, interest rate markets will price interest rate rises, and AUD/USD will appreciate.