*Reasons why the AUD is falling (1) The AUD is an extremely liquid currency. According to the Bank of International Settlements (BIS), the AUD/USD exchange rate is the 4th most liquid currency in the world. Australia's financial markets are deep and among the most sophisticated in the world. Hence participants can get pricing for large volume trades.
(2) Australia's exports make up approx 22% of the economy and commodities make up the bulk (approx 60%) of Australia's exports. Participants take the view that as global growth estimates get revised down, commodity prices will fall and Australia's exports and economy will slow. Putting large downward pressure on commodity prices, is the high possibility of a technical recession in the US, Eurozone and Japan. Indeed, a global recession is certainly a real possibility. Because the AUD is a very liquid currency, participants can ride the slowing global growth-commodity price cycle by selling the AUD.
(3) In times of risk aversion, the currencies of current account deficit countries tend to get sold and the currencies of current account surplus countries tend to get bought. Rising credit costs raise the costs of funding current account deficits, even if the ability to fund the deficit is not directly under the threat. Nevertheless, rising risk aversion leads participants to avoid the additional risk that current account deficit's bring to the equation, by selling the AUD.
(4) As global growth slows, the RBA reduces interest rates to insulate Australia's economy from the slowing global environment. Unless the current account deficit falls at the same time, the risk premium on Australia's interest rates is effectively reduced as interest rates fall. Hence, a lower AUD is required to compensate incoming investors willing to fund the current account deficit, for the lower interest rate (risk premium) environment.
(5) The USD is rising because demand for USD has increased exponentially as local US banks and foreign banks with US$ loan exposure scramble to appropriately match US$ denominated funding requirements (matching US$ assets and liabilities) and support US$ denominated capital adequacy ratios. Consequently, US institutions with an offshore presence are repatriating USD and foreign institutions with local exposure in the US are gathering USD to meet US$ funding requirements. The USD is also rising because the US authorities are seen to be addressing the credit crisis. There is a perception that the US economy, first into the downturn is likely to be first out. Certainly the US economy recorded stronger GDP growth than most of the industrialised world in Q2. While Q3 growth is less certain, large interest rate cuts are expected from the ECB and BoE putting downward pressure on those currencies, as their respective authorities grapple to deal with the credit crisis. A stronger USD is putting downward pressure on the AUD.
** Since the introduction of the euro in January 1999, the record low has been 0.5175. If we use a proxy for EUR (pre 1999), the record low is 0.4902, reached in September 1992.
