The 2008 Global Credit Crisis caused world leaders to move in concert with one another to a degree and manner the world may have never seen before.  Central Banks and world governments pledged to flood their respective economies with easy credit by slashing interest rates to unprecedented, historic lows.  Now, two years later, countries throughout the world are beginning to see light again to some degree.  Another Great Depression was subverted, for now, and economies are beginning to expand once again. 

It is interesting to note that the entire global economy was thrust into the Credit Crisis together; however, each country is emerging from the Crisis at different speeds.  Two countries that are emerging from recession at very different speeds are the U.S.A and Australia.  As an FX Trader, if one understands the complexities of which fundamental drivers directly affect the currency value of these two countries, one can be better prepared to successfully profit from the enormous swings this currency pair offers.

In order to understand the complexities of currency valuation, one must first have a basic understanding of interest rates.  Interest rates, by far, are the determining factor of currency valuation over the long term.  In fact, interest rates are the key driver of the Aussie/US Dollar currency pair.  One way to speculate successfully in the Forex Market is to pair two currencies that have a wide interest rate spread between them.  This pair qualifies.  As a rule of thumb, the Aussie Dollar is recognized as a currency that carries a relatively high interest rate.  Conversely, the U.S. Dollar is recognized as a currency that carries a relatively low interest rate.  Let us examine why.

Economic Growth

Central Banks manipulate the economy by controlling the money flow.  They control the money flow by manipulating interest rates.  And as we have noted, currencies are driven by interest rates.  The stated goal of a Central Bank is to create an economic environment of solid growth measured by Gross Domestic Product (GDP), while maintaining low levels of unemployment and keeping inflation at its targeted level.

A Central Bank will lower interest rates in order to flood the economy with money.  With low interest rates, companies will borrow in order to expand operations, which will in turn increase employment figures, which will in turn cause consumers to spend more money.  The economy grows.  However, at a certain point, inflation will kick in as the economy begins to grow too fast.  At this point, the Central Bank will intervene by raising interest rates, which will cause the economy to slow down to speeds of normal growth.  So, traders and investors analyze economic growth very closely in order to determine when a Central Bank may raise or lower interest rates.

Why Traders and Investors Love This Pair

Since Australia is regarded as a high yielding currency pair and the US Dollar is regarded as a low yielding currency pair, traders and investors will generally borrow money in the low-yielding US Dollar and then place it in the high-yielding Aussie Dollar.  This basic investing philosophy is referred to as the carry trade.  Thus, when Australia’s economy is doing well, and inflation is a continual threat, the Aussie/US Dollar pair will rise due to the Royal Bank of Australia offering very high interest rates.  However, when global or national recession is a threat, and the economy begins to slow, Australia will lower rates, and investors will remove their funds from the Aussie Dollar because they are not getting high yield, which will in turn cause the Aussie/US Dollar currency pair to be devalued.  Yield and risk appetite/aversion drive this currency pair.

As a trader, one should closely follow Producer Price Index and Consumer Price Index figures released out of Australia each month.  These figures are leading economic indicators of inflation, which can give clues to future Central Bank decisions.  To find out more information about these economic releases, a person should visit a few of the best forex brokers.  They often times have very informative and free information about these indicators.

Current Outlook on Aussie/US Dollar

In the U.S.A., the Federal Reserve has pledged to keep interest rates at exceptionally low levels for an extended period of time.  Conversely, Australia has been raising interest rates.  The interest rate spread between the two pairs in increasing, which is causing the Aussie/US Dollar to continue to increase.  As an investor playing this currency pair, one should keep a close eye on US Dollar inflation readings, CPI and PPI.  It is a commonly held view by economists that the Federal Reserve will keep these low interest rates until inflation becomes a threat.  If these inflation readings get above target levels in the U.S., then interest rates will be raised, which will cause the interest rate spread between the Aussie and the US Dollar to tighten, which will, consequently, cause a devaluation of the pair.  Understanding inflation and interest rate principles gives traders an edge in knowing how to trade the Aussie/US Dollar successfully.

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(C) Copyright, Michael Trinkle, 2010