Iron ore is one of the biggest drivers of the Australian dollar. Western Australia is the world’s largest iron ore producer. As a result, the Australian economy is expected to perform better with stronger iron ore prices. Iron ore futures declined by almost 30% since August and the Australian dollar topped in September and then turned bearish, losing more than 6% of its value on a trade-weighted basis, according to Deutsche Bank’s trade weighted spot index.
While the decline in iron ore prices was one plausible explanation for the Aussie’s depreciation, it was not the only one. The quickly narrowing interest rate differential between the Aussie and other currencies has certainly enhanced the downside move, as carry traders stepped out of AUD when they found less profit in investing in a high-beta currency. As an indication, the AU/US 2-year yields stood at 2.00%/1.44% respectively two months earlier versus 1.77%/1.76% this week.
The Reserve Bank of Australia’s dovish stance has certainly driven falling Aussie rates, although many developed countries’ rates also went down during the same period.
This week, the RBA's meeting minutes revealed concerns about low wage growth and tame inflation. According to policymakers, globalization and technology could mean low unemployment, but that does not necessarily put positive pressure on inflation. Hence, the RBA is in a good position to keep its benchmark interest rate at the historical low rate of 1.5% as long as inflation allows. RBA’s Governor Lowe said that there is ‘no strong case for near term adjustment in the policy.’
As a result, the carry traders could not be counted on to prevent the Aussie from sliding below the 0.75 level against the US dollar.
What Can Save The Aussie?
Over the past two months, iron ore futures have been exchanged at the bottom of the year-to-date price range. Recently, the iron ore market picked up momentum and futures have gained 10% since the end of October.
As the positive momentum strengthens, there could be a bullish breakout in iron ore prices. And that could be positive for the Aussie, as it trades near five-month lows against the greenback. Tactical long positions should, however, be careful while playing against the trend. Upside moves could be limited and volatile. The key resistance could be found at 0.7705 (200-day moving average).