An Introduction to the Australian Dollar or Aussie (AUD)

The Australian Dollar (AUD) is the currency of Australia. Located in the southern hemisphere, Australia is a federal country comprising mainland Australia and Tasmania. Changes in government interest rates can have a significant impact on the foreign exchange market.

As one of the seven continents in the world, the entire Australian continent belongs to the territory of Australia, with an abundance of soil and natural resources. Australia is the world's leading exporter of minerals and agricultural products, trading mainly with Asian countries such as Japan and China.

The characteristics, benefits, and drawbacks of the Australian dollar are explained in detail below.

The Australian Dollar is the currency of Australia. Once a high-interest currency, the Australian dollar lost value following the 2008 collapse of Lehman Brothers as a result of the nation's benchmark interest rates declining. Before 2008, at one point in time, the benchmark interest rate was above 5% (rising to around 7% in 2008).

Even so, Australia, being a globally advanced country, has relatively low political or economic instability, so the risks associated with the currency are relatively low. Despite Australia's stability, its vulnerability to China's economy and commodities demands scrutiny in currency trading. China is Australia’s main export market. When trading AUD pairs, monitoring China's economic trends and commodity market dynamics is crucial.

The Australian dollar has the following six main features:

1. The trading volume ranks 6th in the world
2. It is easily influenced by the commodity market
3. It is exposed to the Chinese economy
4. Monitor the RBA (Reserve Bank of Australia) trend that determines the interest rate
5. Correlation between Australian and US bond yield spreads
6. Australia has an excellent credit rating and low credit risk

We will explain these features in detail below.

The trading volume ranks 6th in the world The Australian dollar ranks sixth in the world for trading volume

The Australian dollar ranks sixth globally in trading volume. Here is the foreign exchange trading volume data published by the Bank for International Settlements (BIS) every three years (April 2022).

According to data from April 2022, the Australian dollar ranks 6th in global trading volume. The below data is from the Financial Futures Association of Japan, a financial regulatory agency, on "OTC Forex Monthly Express (trading amount of each currency pair).

AUD/JPY pair is part of this list and is often a popular currency pair for trading due to its relatively low volatility. Apart from the dominant trading volume of USD/JPY, the ranking of GBP/JPY, AUD/JPY, and EUR/USD changes over time. Example: The AUD/JPY pair overtook the popular GBP/JPY pair in May 2022 and moved to second place.

It is worth noting that non-primary currency pairs are more prone to sudden changes due to supply and demand imbalances.

It is easily influenced by the commodity market The AUD is easily influenced by the commodity market

The Australian dollar serves as the currency of a major resource-rich nation abundant in energy and minerals. Over half of Australia's exports, including iron ore and coal, stem from these resources, establishing a direct link with commodity markets. This explains the chart below, where as iron ore and oil prices rise, a clear correlation emerges in the AUD/JPY movement. The Australian dollar tends to rise in tandem with resource price hikes. When engaging in Australian dollar trading, diligent monitoring of the commodity market is essential.

The following chart compares the price movement of the AUD/JPY with iron ore and oil prices (WTI crude futures "USOIL").

When trading the Australian dollar, we should also monitor the commodity market.

It is exposed to the Chinese economy The AUD is exposed to the Chinese economy

As China ranks first in the proportion of exports and imports to Australia, it is closely related to the Chinese economy. The next chart compares the movement of AUD/JPY with Hong Kong's Hang Seng Index (HSI).

The correlation between AUDJPY and HSI has decreased from the second half of 2021

We can see a high correlation between the two from 2006 to the first half of 2021.

However, from the second half of 2021 on, the correlation gradually decreased.

The main reasons for this fall are worsening diplomatic relations and COVID-19.

Nevertheless, China still ranks first in terms of exports and imports.

It is therefore necessary to keep an eye on China's economic trends.

Here are some of the most important economic indicators for Australia and China:

Among the economic indicators in Australia, we should pay attention to the announcement of interest rates, employment statistics (unemployment rate, new employment), and GDP. Furthermore, China's economic indicators, which are closely related to trade, should also be identified.

We can use the Economic Indicators Calendar provided by OANDA to confirm the publication dates of the different economic indicators.

We can find out about the latest information on the economic indicators relating to Australia and China in Section 7 of this article.

Monitor the RBA (Reserve Bank of Australia) trend that determines the interest rate.

As mentioned in Feature 3, it is vital to check the Australian economic indicators before analyzing the market movements of the Australian dollar.

In particular, investors should keep a close eye on the RBA (Reserve Bank of Australia), which determines the interest rate. The reason is that in a stable economy, it is generally better to invest money in countries with high interest rates (better to buy).

Why should you buy currencies with high interest rates?

For example, the Australian dollar has an interest rate of 2.5%, and the Japanese yen has an interest rate of 0%.

If you invest 1 million yen in one year, the Australian dollar will be worth 1,025,000 yen after one year, while the Japanese yen will still be 1 million yen.

(This is just an example and does not consider exchange rates and taxes.)

Which currency do you prefer: the Australian Dollar or the Japanese Yen?

Most people will say they would like to use the Australian dollar.

In this case, more people will buy Australian dollars and sell Japanese yen, leading to an increase in the price of Australian dollars and a decrease in the price of Japanese yen.

Once the interest rate difference widens, it will accelerate the buying of Australian dollars and the selling of Japanese yen. However, when specific impacts cause economic instability, there may be a reverse flow of investment funds.

Such interest rate fluctuations will significantly affect the movement of the FX market.

Always check the RBA's (Reserve Bank of Australia) movements before trading the Australian dollar. In addition, the CPI (consumer price index) is one of the reference factors when setting the interest rate. Knowing the CPI can predict the movement of the policy rate so that we can check it together.

The correlation between Australian and US bond yield spreads

AUD/JPY also correlates with the Australian 10-year bond yield spread and the US 10-year bond yield spread. The general value of AUDJPY has a relationship with the Australian 10-year bond yield and the US 10-year bond yield spread.

Also, as mentioned in Feature 4, we should identify the interest rate spread as it has an impact on the FX market.

Australia has an excellent credit rating and low credit risk

Australia, as a country, has an excellent credit rating and low risk.

• What is a credit rating?
  It is the standard for determining the credit risk of bonds such as government bonds and corporate bonds. Credit rating agencies such as Moody's, Standard & Poor's (S&P), and Fitch determine the credit ratings.
• What is credit risk?
  It refers to the possibility of a country defaulting on its debts (not paying principal or interest payments, etc.) because of financial difficulties or poor management. If the debt is in default, it may lose the principal.

As of November 2022, three major credit rating agencies (S&P, Moody's, and Fitch) have rated the country as Triple A (AAA) - the highest rating. The Australian Dollar, the currency issued by Australia, is considered safe to trade because of the country’s excellent credit rating and low credit risk.

Having examined the features of the Australian dollar, now we will analyze its movement using the example of the AUD/JPY from different perspectives.

There are five critical points for observing the future movement of the Australian Dollar/Japanese Yen (AUD/JPY).

• Policy rates
• The commodity markets
• Trade relations with China

These are explained in detail below.

Policy rates

The following graph shows how the Australian policy rate has moved over the past 20 years.

The Australian dollar, with interest rates around 7% in 2008, was known as a high-interest currency. After that, rates experienced a downward trend, reaching their lowest level of 0.1% between 2021 and 2022. However, the monetary policy meeting in May 2022 raised the interest rate to 0.35%, and it continued to rise slowly after that, reaching 2.6% in October 2022, 2.85% in November 2022, and 3.1% in December 2022.

The RBA continued to raise rates in 2023, and the last rate hike was in November 2023 by 25 basis points to 4.25%.

The central bank in the November 2023 meeting noted that

Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks.

The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.

The commodity market in Australia

The global economy is at risk of stagflation (a combination of stagnation and inflation) due to COVID-19. Australia is one of the countries that has benefited from the rising commodity markets.

The following graph compares the AUD/JPY with the CRB Index (Reuters/Jefferies CRB Index).

What is the CRB Index?

It is a representative international commodity futures index of 19 items, including oil, natural gas, gold, silver, copper, corn, and soybeans.

It is a leading indicator of global price, economic, and inflation trends.

The CRB Index movement

The CRB index also fell sharply in 2020 due to the global economic slowdown caused by the COVID-19 outbreak, but it rose significantly again between then and 2022. The CRB Index has increased by 13.55 points, or 4.50%, since the beginning of 2023. This upward trend is likely due to overall global inflationary pressures and the lack of geopolitical tensions between Russia and Ukraine.

If the commodity market rises, it will rally the AUD/JPY, but if it falls, the AUD/JPY often follows lower. It is important to keep an eye on commodity prices and the outlook for commodities when forming views on the movements of AUD/JPY.

Trade relations with China

As economic partners, Australia and China have contributed significantly to each other’s economic development. But the relationship between the two countries began to break down in April 2020. Former Australian Prime Minister Scott Morrison called for an independent international investigation into the origin of the coronavirus. It triggered a strong reaction from China, which imposed massive trade sanctions on Australia.

Australia-China relations have deteriorated since then, leading to trade chaos. Nevertheless, China still ranks first in Australia's import/export ratio. While there are still no signs of improvement in relations, we should continue to monitor the trade relationship with China.

Two ways to invest in the Australian Dollar

There are two ways to invest in the Australian dollar:

1. Forex (Forex margin trading)
2. Foreign currency deposits

Each investment method is explained in detail below.

Forex (Forex margin trading)

Forex, also known as "Forex margin trading," is an investment that generates profits or losses from buying or selling currencies such as the Australian Dollar or US Dollar. With leverage, we can start trading with a small margin and trade 24 hours a day. It is a highly liquid market. Despite the many advantages of forex, there are also risks. For example, it is possible to generate losses higher than the margin in leveraged trading, so carefully managing risk when trading is essential.

Foreign currency deposits

A foreign currency deposit is a way to convert your local currency into a foreign currency, such as the US Dollar or Euro, and use it as a deposit. You can also receive interest during the foreign currency deposit period.

Interest rates on foreign currency deposits vary depending on the currency and may achieve higher interest rates than the local currency.

However, foreign currency deposits carry the risk of exchange rate changes and may lose money if the value of the foreign currency falls.

The following table compares each investment method.

First of all, the most significant difference is leverage.

In Forex, the leverage can be up to 1:888 (for individuals), but foreign currency deposits have no leverage.

Therefore, the capital efficiency of Forex is superior. However, it is crucial to remember that targeting huge profits may also result in significant losses when trading with leverage. In addition, there are significant differences in how you buy and sell. As Forex can be bought and sold, profits can be made regardless of whether the price of the foreign currency is high or low.

However, foreign currency deposits are only available for purchase, so they cannot benefit from low foreign currency prices. As mentioned above, if we invest in the Australian dollar from a capital efficiency perspective, forex may be the best option. The advantages and disadvantages of forex are explained in detail below.

Four advantages of investing in the Australian Dollar with Forex

Using Forex to invest in Australian dollars has four main advantages.

1. With leverage, a small amount of funds can generate significant profits
2. You can trade 24 hours a day on weekdays
3. Profit from overnight interest
4. Forex can be used as a hedge for other investments

We will explain each one in detail below.

With leverage, a small amount of funds can generate significant profits

Leverage is very common in forex trading. As the leverage is up to 1:888, the required funds for trading can be 1/888 of the original amount. This has the advantage of efficiently using funds because a trader can start trading with a small amount.

In the case of EUR/USD at 1.2000, for example, it would take USD120,000 to trade one lot (100,000 units of currency) of Euros, but we can trade with leverage at about USD135. A price movement of USD 0.0001 will generate USD 10 of profit, so even small amounts can make significant profits.

Moreover, leverage is not the only reason we trade Forex with small amounts of money.

It is also related to the minimum trading volume set by the forex company. With OANDA, for example, you can start trading with a minimum of 0.01 lot (1000 units of currency).

You can trade 24 hours a day on weekdays

Forex can be traded 24 hours a day (except Saturday and Sunday). Forex connects markets around the world. Due to the different features of price movement in each session, we should develop strategies accordingly. In addition, there are also sessions that you must pay special attention to when trading.

Please refer to the following articles for the sessions when prices fluctuate and are particularly important during trading.

Profit from overnight interest.

In addition to the benefits of the exchange difference, Forex can also earn on the overnight interest rate or rollover rate (the difference in interest rates between two countries).

What is overnight interest?

It refers to the interest rate difference between the two countries of a currency pair. If we buy currencies with high interest rates and sell currencies with low interest rates, we can make profits every day. However, if we buy currencies with low interest rates and sell currencies with high interest rates, we must pay a negative overnight interest rate.

For the structure and application of overnight interest, please refer to the following article:

What is overnight interest? Introduction to calculation methods, etc.

In forex trading, many people may think they need to target profits to buy and sell frequently, but they can also continue to obtain long-term benefits through overnight interest. Australian dollar interest rates were around 7% in 2008. It has attracted much attention as a high-interest-rate currency and has also created the trend of carry trades between buying Australian dollars and selling Japanese yen. However, due to the impact of the Lehman Brothers crisis, frequent interest rate cuts, and easing monetary policy (low interest rate policy) in the context of COVID-19, the interest rate of the Australian Dollar has fallen, and the spread between the Australian Dollar and the Japanese Yen also decreased in 2022. Some of this trend reverted in 2023 as the Reserve Bank of Australia again went on a rate hike spree to fight inflation.

Forex can be used as a hedge for other investments

As forex can benefit both buyers and sellers, it can be used as a hedge for other investments.

Take the example of using the Australian dollar through foreign currency deposits and assume that unrealized gains arise. The unrealized gains will naturally decrease once the Australian dollar is in a downward trend.

While there are many advantages to investing in the Australian dollar with Forex, there are also risks.

The next section explains the disadvantages of investing in the Australian dollar with Forex.

There are three disadvantages to using Forex to invest in the Australian dollar.

1. Highly leveraged trade carry a high risk
2. May have spread
3. Risk of margin closeout

These are explained in detail below.

Highly leveraged trade carries a high risk

When trading with leverage, funds must be properly managed. The reason is that when trading on margin, if the margin falls below a certain level due to unrealized losses, there will be a margin closeout (forced settlement).

Failure to trade with an appropriate number of holdings for margin increases the risk of margin closeout due to small price movements. To manage risk, traders can use a strategy called 'risk-reward.' This means looking at the potential profit and loss for each trade. It helps compare the risks and benefits of a trade. By using risk-reward, traders can decide if their current approach will keep making profits in the future. Professional investors also use risk rewards when trading.

May have spread

Forex trading may have spread.

The spread is the difference between the bid price and the ask price and is a transaction cost for investors because it accumulates as an unrealized loss.

We can consider a spread as a transaction fee. The spread is generated according to its value and may increase due to market conditions.

In addition, it may be impossible to trade at the expected price due to execution speed and slippage. The resulting price deviation can also become a transaction cost. When choosing forex brokers, we should consider the spread, confirm, and compare the execution speed and slippage.

Risk of margin closeout

Forex trading involves the risk of margin closeout.

Margin closeout is a mechanism whereby forex brokers force settlement when losses exceed a certain standard to avoid losses exceeding the margin investors pay. Its purpose is to protect investors and ensure that even if there is a margin closeout, a certain margin will still be left in the account.

However, if the price changes sharply in a short period for specific reasons, it may be impossible to carry out a margin closeout in time, resulting in losses higher than the margin.

In this case, depositing a large margin and controlling the number of positions is essential so they are not affected by sudden market movements.

When trading Australian dollar pairs, knowing what's happening in the Australian and Chinese economies is essential. To understand the economic trends in Australia and China, we must monitor some key economic indicators. They should be used as a reference,as they reflect the latest information.

Key economic indicators for Australia:

1. GDP
2. Interest rate
3. CPI (Consumer Price Index)
4. Unemployment rate
5. Changes in the number of employed people

Key economic indicators for China:

1. GDP
2. Interest rate
3. Mining and industrial production
4. The Purchasing Manager's Index (PMI data)

OANDA offers a wide range of currency pairs that include the Australian Dollar:

Finally, here is the summary for the Australian dollar.

1. The Australian Dollar is the currency of Australia and a representative resource country currency
2. When trading the Australian Dollar, keep an eye on interest rates and developments in the Chinese economy, the commodity markets, etc.
3. Although forex is a very effective investment method, it requires risk management
4. OANDA offers a wide range of trading for Australian Dollar pairs