The Australian Dollar is influenced by financial market sentiment, commodity prices and the RBA. But the influence of these variables is constantly evolving. This special report breaks it down.
We will start with the importance of relative monetary policy. The dark red line on the chart below is the rolling bond yield spread coefficient and how it changed over time. When this line is rising above 0, that means a 1 percentage point improvement in 2-year bond yield returns in Australia relative to the United States produced an increasingly more positive reaction from AUD/USD , controlling for EEM and BCOM.
So, what happened to this relationship? The yield advantage that Australia once had relative to the United States slowly evaporated after the 2008, turning negative heading into Covid and remaining mostly thereafter. In other words, interest rates in the US became higher than in Australia. As this happened, the ability of RBA monetary policy to influence AUD/USD weakened significantly and remained so in the few years after Covid.
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