Australian dollar rallies but Coronavirus and economy will dictate its direction

The rise of the Australian dollar has been a notable feature of fast-changing markets over the past few months. Since the currency hit a low of US55 cents in March, the peak of the coronavirus crisis, it has rallied more than 20 per cent.

It is no coincidence the Aussie dollar’s low in March correlated with the weakest point for share markets and its run up happened as markets also recovered ground.

Rising currency reflects improving economic news

The Australian dollar is a pro-cyclical, commodity-based currency and when we get better news about the global economy and more support for share markets, we tend to see the dollar rally, as has been the case.

Over the past three months we’ve witnessed a huge rally and that’s because Australia is faring better than a lot of nations in managing the virus and a dividend of that will be comparative economic outperformance – despite the country entering its first economic recession in decades.

Has the Aussie dollar hit its ceiling?

It will be difficult for the Australian dollar to appreciate much past US70 cents in the current environment. It is likely to remain in a range between US65 – 70 cents.

One of the biggest negative factors for the currency is its sensitivity to the pandemic. A potential second wave of coronavirus in Australia or globally would of course damage the world economy and accordingly, the Aussie dollar.

As a commodity currency, there are also risks associated with trade tensions between China and the United States

Domestic risks

There are factors closer to home that are likely to restrain the dollar from appreciating past US70 cents at this point. While Australia has weathered the coronavirus crisis better than many countries, there is a risk we’ll see significant collateral damage from businesses closing down when the economic slowdown bites further.

We are also yet to see the impact of the Australian Government’s Jobkeeper and Jobseeker programs being wound down in September, but it could come earlier. As part of the Government’s response to coronavirus, Jobseeker pays employers $1,500 a fortnight to keep staff employed while Jobseeker has temporarily doubled the former Newstart allowance to $1,100 a fortnight.

Stronger dollar – weaker economy

An Australian dollar above US70 cents spells bad news for economic growth in Australia, due in no small part to diminished returns on exports. If the dollar was to rise above that level for a sustained period of time, it is likely in our view, that the Reserve Bank would intervene in the market through quantitative easing to bring the dollar back down.