Five reasons why the Australian dollar is likely to resume its upswing over the next 12 months

September 16th 2021

Key Points

  • Since its February high of around $US0.80 the $A the $A has fallen on the back of global growth concerns, a slowdown in China and the Delta outbreak in Australia.
  • However, there is good reason to expect the $A to resume its rising trend: sentiment towards the $A is negative; global growth is likely to remain strong; commodities look to have entered a new supercycle; Australia has a large current account surplus, and Australia is likely to see strong growth next year.
  • There is a case for Australian based investors to tilt a bit to hedged global investments but while maintaining a still decent exposure to foreign currency given the diversification benefits it provides.



Movements in the value of the Australian dollar are important for Australian-based investors in that they directly impact the value of (and hence returns from) international investments and indirectly affect the performance of domestic assets like shares via the impact on Australia’s competitiveness. But currency movements are also one of the hardest things to get right. This year has been no exception with the $A initially surging to $US0.80 in February only to then fall to a recent low of $US0.71. This note takes a look at the outlook for the $A.


The $A is around long-term fair value

From a long-term perspective, the $A is around fair value. The best guide to this is what is called purchasing power parity (PPP) according to which exchange rates should equilibrate the price of a basket of goods and services across countries – see the next chart that shows annual data for the $A back to 1900.


5 reasons $A 1
Source: RBA, ABS, AMP Capital


If over time Australian inflation and costs rise relative to the US, then the value of the $A should fall to maintain its real purchasing power. And vice versa if Australian inflation falls relative to the US. Consistent with this the $A tends to move in line with relative price differentials – or its purchasing power parity implied level – over the long term. And right now, it’s around fair value. So, nothing to get excited about, right?

But as can be seen in the chart, it rarely spends much time at the purchasing power parity level. Cyclical swings in the $A are largely driven by swings in the prices of Australia’s key commodity exports and relative interest rates, such that a fall in Australian rates relative to US rates makes it more attractive to park money in the US and hence pushes the $A down. “Investor” sentiment and positioning also impacts – such that if the $A is over-loved with investors overweight in it then it becomes vulnerable to a fall and vice versa if it’s under-loved.


Why has the $A fallen since February?


But there are five positives likely to push the $A up

Against this, there are a bunch of forces suggesting that what we have seen since February is most likely part of a correction.


5 reasons $A 2
Source: Bloomberg, AMP Capital



5 reasons $A 3
Source: Bloomberg, AMP Capital



5 reasons $A 4
Source: ABS, AMP Capital



So where to from here?

Ultimately, we expect the positives notably in the form of strong global growth and high commodity prices to triumph over the negatives and push the Australian dollar higher, and over the next 12 months see it rising to around $US0.80-0.85.


What does it mean for investors?

A rise in the value of the Australian dollar will reduce the value of an international asset (and hence its return) by one for one, and vice versa for a fall in the $A. So last year global shares returned 13.8% in local currency terms but only 5.7% in Australian dollar terms as the $A rose in value. So, when investing in international assets an Australian investor has the choice of being hedged (which removes this currency impact) or unhedged (which leaves the investor exposed to $A changes). Given our expectation for the $A to rise over the next 12 months there is a case for investors to tilt towards a hedged exposure of their international investments.

However, this should not be taken to an extreme for two key reasons. First, currency forecasting is hard to get right. Second, having foreign currency in an investor’s portfolio via unhedged foreign investments is a good diversifier if the economic and commodity outlook turns sour. As can be seen in the next chart there is a rough positive correlation between changes in global shares in their local currency terms and the $A. Major falls in global shares which are circled in the next chart saw sharp falls in the $A which offset the fall in global shares for Australian investors. So being short the $A and long foreign exchange provides good protection against threats to the global outlook.


5 reasons $A 5
Source: Bloomberg, AMP Capital


Finally, the last commodity supercycle in the 2000s saw Australian shares outperform global shares, so one way to play a new commodity super cycle would be via a higher exposure to Australian shares.

If you have any questions about this please contact us.

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About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.