The Australian Dollar Is Heading To USD 71 Cents

The Australian Dollar Is Heading To USD 71 CentsSummary

• The remarkable rise of the iron ore price has helped strengthen the Australian dollar to US 77 cents.
• This rise, fuelled by Chinese demand for steel, is expected to be short-lived.
• This should cause the Australian dollar to weaken from where it is currently, as well as iron ore related stocks.
• Rate rises in the US and rate cuts in Australia will help guide the AUD down to US 71 cents.

Following a remarkable rise in the iron ore price, the Australian dollar staged an even more remarkable rally against its U.S. counterpart. But the good news for those shorting the Australian dollar, is that the rally cannot last according to many economists.

There is a strong correlation with the price of iron ore and the Australian dollar. That is quite understandable to some degree, considering Australia is responsible for just over half of the world’s iron ore exportsthrough mining behemoths such as BHP Billiton (NYSE:BHP) and Fortescue Metals (OTCQX:FSUGY).

What this means for the Australian dollar.

Much like BHP Billiton or Fortescue Metals, the Australian dollar also has a strong correlation to the iron ore price. So when the iron ore price drops again, which we expect it will do soon, the Australian dollar will also drop.
*FXA above is the AUD exchange rate expressed in USD

…we would pick June 2016 as being the first [interest] rate rise [by the Federal Reserve in the US] this year. When this does occur we have little doubt that the Australian dollar will depreciate as low as US 71 cents [against the USD], representing a huge 8 percent drop from the last trade price.

Although we differ on timeframes, Australia’s second largest bank Westpac (NYSE:WBK) also sees the Australian dollar dropping down to US 71 cents.

Click to enlarge

Sourced from Westpac Weekly

1. Based on the above source what main factor has caused the appreciation in April 2016 in the AUD against the USD? Explain this with reference to theory and an economic model. (You DO NOT have to draw a diagram but can describe a diagram) (8 marks)
2. Briefly explain why an increase in interest rates by the Federal Reserve in the US in June 2016 would mean the AUD would depreciate against the USD. (You DO NOT have to draw a diagram but can describe a diagram) (7 marks)
3. Based on economic theory do you believe demand for USD would be relatively elastic or relatively inelastic? Why? (You may need to do some limited research here but DO NOY FORGET to refer to relevant economic theory) (5 marks)
• Please remember to reference your answers and provide a reference list at the bottom.
• DO NOT exceed 200 words by more than 10%
• An example of a discussion case study answer will be posted in Week 3.

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