FX BEAT: Why a weaker A$ is a useful “shock absorber”

If you’ve travelled overseas this holiday season, especially to the U.S., you’ve probably noticed that your Australian dollars don’t go as far as they used to.

The Aussie currency has fallen around 10 percent against the U.S. dollar since the start of October to its lowest in nearly five years. 

But while the weaker A$ can make overseas trips more expensive, it’s part and parcel of having a floating exchange rate that acts as a “shock absorber” for the economy says Westpac Chief Economist Luci Ellis. 
 

The latest sell-off in the Aussie is more about the strength of the U.S. dollar rather than anything specific to Australia, she notes - the A$ has only declined by about 5 per cent against a trade-weighted basket of currencies since October. 

The greenback has blasted higher across the board since Donald Trump won the Presidential election in November, primarily on the market’s view that Trump’s America-first, tax-cutting policy agenda will boost economic growth and lead to U.S. interest rates staying higher for longer to contain inflationary pressures. 

We’ve seen similar periods of “American exceptionalism” before, Ellis notes. For example, around the height of the tech bubble in 2000 when the Aussie fell to levels well below where it trades currently. The A$ has also been hit at times of global turbulence such as the 9/11 terror attacks in 2001 and the Global Financial Crisis of 2007/08.

As an open, commodity-exporting economy, Australia is seen by investors as being more vulnerable to these events because of their potential to weaken global demand and trade. However, that A$ weakness does not last forever and in the meantime serves a valuable purpose. 

“Australian production becomes more price competitive relative to foreign alternatives, which boosts domestic activity over time,” Ellis says in a research note. “The domestic-currency values and income of Australia’s foreign assets (Australia has net foreign currency assets) rise, so too the profits of externally-focused Australian firms such as our mining companies. These in turn boost tax revenue for the Australian government.”

Another positive side-effect of a weaker A$ is that it makes the country more affordable for foreign visitors, providing a welcome boost to the tourism industry. 

Ellis adds that the A$’s role as a “shock absorber” will be crucial in the years ahead as the country navigates the structural limits to growth in demand for its top foreign exchange export earners: iron ore, coal, liquefied natural gas and education. 

To read Luci’s full note, visit WestpacIQ.

Where to from here?

While the U.S. dollar rally is at a “mature” stage, the underlying drivers behind its strength remain intact, says Richard Franulovich, Head of FX Strategy at Westpac. As such, he can’t rule out the A$ extending its slide below 60 cents per U.S. dollar in the coming weeks and months.

Economists had been upgrading their forecasts for U.S. growth even before Trump’s win, with consensus estimates now suggesting it could outstrip Eurozone growth by up to 2 percentage points in 2025. 

Add to that the uncertainty over Trump’s trade policy, and his threat of punitive import tariffs which could crimp global trade more broadly, and the case for a sustained rebound in the A$ is “not persuasive,” Franulovich says. 

“Trump has vowed to hit the ground running and we’ll find out crucial details about the size and scope of the tariff threat in coming weeks,” he says. “Markets are bracing for an aggressive set of protectionist trade policies, so a more gradual approach could give the A$ a short-term boost. The caution is that unpredictability is a big part of Trump’s brand.”  

As long as the U.S. dollar reigns supreme, travellers might want to consider cheaper alternatives to America for their next big overseas trip. New Zealand, for example, where the A$ now buys more NZ$s than it did in October. The Kiwi dollar has fared even worse than the Aussie following a series of interest rate cuts from the RBNZ to support the sluggish economy.   


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