Under multiple shocks, the Australian dollar unexpectedly shows resilience against declines

Ask AI · How does the Middle East energy crisis help the Australian dollar strengthen against the trend?

Recently, the Australian dollar has outperformed expectations, mainly due to disruptions to Middle East energy supply. Asian countries have begun to turn to Australia to seek alternative sources of natural gas and coal, which has pushed up prices of related commodities. At the same time, the Australian dollar has also been supported by the Reserve Bank of Australia. In the long run, the Australian dollar may continue to trend higher.

Amid recurring geopolitical turmoil, disrupted energy supplies, and highly volatile market sentiment, the Australian dollar—often dubbed the “global risk barometer”—should, in theory, weaken under this shock. However, its recent performance has been stronger than expected.

Analysts say that given the stakes of developments in the Middle East this week and a range of possible outcomes, the Australian dollar may lead market direction.

This week, the Australian dollar got off to a good start: the Australian dollar/US dollar rebounded and regained the key 0.6900 level. On Tuesday, the Australian dollar maintained a positive trend, driving the Australian dollar/US dollar exchange rate to a four-day high near 0.6950, and also opening the door for a possible renewed push at the psychological 0.7000 level in the short term.

Limited Downside Amidst the Fighting

Because of its high liquidity and positive correlation with commodity prices, the Australian dollar is often viewed as a risk currency that reflects market sentiment.

Tight geopolitical conditions typically increase demand for safe-haven currencies such as the US dollar, which may limit the Australian dollar’s upside or even cause it to fall.

In late February, the US-Iran conflict broke out. In the past, this might have triggered selling of the Australian dollar—for example, in a similar incident in 2019, the Australian dollar to US dollar exchange rate saw a brief but sharp sell-off before rebounding.

But in this shock, the Australian dollar against the US dollar fell by less than 3% only, holding around 0.69. The decline versus a basket of major trading partner currencies was also only about 2%. Given Iran’s de facto blockade of the Strait of Hormuz, such performance appears relatively resilient.

Ray Attrill, head of FX strategy at National Australia Bank (NAB), said that with a geopolitical shock of this magnitude, the fact that the Australian dollar can still maintain stability already shows a considerable degree of resilience.

Two Key Factors Supporting Resilience

The reason the Australian dollar did not weaken sharply like typical risk assets—and instead unexpectedly showed resilience to risk—lies in the disruption to Middle East energy supply and the shift by Asian countries toward Australia for alternative supplies of natural gas and coal, which has pushed up prices of related commodities.

Although the closure of the Strait of Hormuz has pushed oil prices to above $100 per barrel and sparked concerns about economic slowdown, because Australia is a major exporter of natural gas and coal, the Australian dollar has remained firm.

Lachlan Dynan, a macro strategist at Deutsche Bank, said the Australian dollar’s resilience is reflected in the exchange rate reaching new highs during the period the conflict has persisted.

On March 11, the Australian dollar touched a four-year high of 71.51 US cents. Although it later retreated to around 69.11 US cents, it is still up nearly 4% since the start of the year.

“The main driver is its position as an energy exporter.” Dynan said. “They sell the commodities that Asia needs at the moment… demand may shift from the Middle East to Australia.”

This shift is not limited to natural gas. As countries are forced to restart coal-fired power plants to avoid oil shocks, Newcastle coal prices have risen by about 20% since the outbreak of the war.

Dynan said: “The Australian dollar is protected on the downside… if the conflict escalates further, Australia’s exposure in the energy sector will provide a buffer for the Australian dollar.”

This reconfiguration of supply and demand means that the Australian dollar’s moves are no longer entirely constrained by fluctuations in global risk appetite; instead, it receives a “backing force” from fundamentals. Even if market sentiment weakens temporarily, expectations of a widening trade surplus driven by energy exports and capital inflows still provide support to the Australian dollar at low levels, making it harder for it to suffer sustained depreciation than other risk currencies.

In addition to commodity-side support, interest rate factors cannot be ignored.

Beyond commodities, the Australian dollar is also supported by the Reserve Bank of Australia. The Reserve Bank of Australia is the only central bank among the G10 group of countries to have raised interest rates during the Iran conflict.

To rein in an inflation rebound, the Reserve Bank of Australia has already increased the cash rate twice this year to 4.1%. Markets expect at least two more rate hikes before the end of the year.

These measures have made Australia’s cash rate the highest among G10 countries for the first time in years, attracting investors seeking higher returns.

Dynan said bluntly that this interest-rate differential advantage is “highly supportive,” helping the Australian dollar remain relatively stable amid market turbulence.

Short-Term Downside Risks

Given the stakes in the Middle East this week and a series of possible outcomes, the Australian dollar may lead market direction.

Before the last deadline previously set by Trump, caution in the market sentiment increased, causing the US dollar to lose some support. On Monday (the 6th), after two consecutive days of decline, the Australian dollar against the US dollar broke above 0.6900.

In the long run, the Australian dollar may continue its upward trend.

Deutsche Bank believes the Australian dollar is a resilient “asymmetric” bet. Its position as an energy exporter shields it from the impact of further escalation in the Middle East, and resolution of the situation could trigger a sharp rise in the Australian dollar.

Dynan expects the Australian dollar to reach 71 US cents before Christmas, saying the Australian dollar “may be one of the best currency trading instruments, because its arbitrage effects are very, very strong.”

Attrill also believes that if the conflict is resolved and oil prices fall, the Australian dollar/US dollar exchange rate will rebound back above 0.70. He also said he expects the Australian dollar/US dollar to reach 0.73 by the end of the year.

A survey by The Australian Financial Review of 36 economists shows that the Australian dollar/US dollar exchange rate will reach 0.72 by year-end.

Meanwhile, according to the latest reports, the US and Iran have agreed to a two-week ceasefire, and negotiations will be held in Islamabad on April 10.

However, this outlook is not without risks.

Richard Franulovich, head of FX strategy at Westpac, warned that the Australian dollar is essentially betting on two very different possible outcomes of the war.

“The Australian dollar is staying balanced between two binary scenarios.” Franulovich said. “If the conflict escalates further—for example, with ground forces getting involved, or the strait being permanently closed—the Australian dollar/US dollar could fall to just above the 0.60 level.”

But if a peace agreement is reached, it could trigger a round of a “strong relief rally,” potentially pushing the Australian dollar/US dollar to around 0.75 before Christmas.

However, with market positioning already tight and seasonal factors indicating increased volatility, the Australian dollar/US dollar may face downside risks in the short term before any sustained upside breakout occurs.

Market analyst Matt Simpson said that the Australian dollar’s strength in the first quarter was mainly driven by rate hikes by the Reserve Bank of Australia that raised domestic interest rates, thereby widening the interest rate differential relative to the Federal Reserve and attracting capital inflows into Australian dollar assets.

But entering the second quarter, this support mechanism began to weaken. On the one hand, Middle East geopolitical risk pushed energy prices higher, making inflation prospects more uncertain and weighing on global economic growth; on the other hand, market expectations for the future policy path of the Reserve Bank of Australia and the Federal Reserve have fluctuated.

Against this backdrop, although the interest rate differential still provides some support for the Australian dollar, slowing growth and a decline in risk appetite are putting pressure on it, resulting in a lack of clear direction as bullish and bearish factors intertwine. In the short term, the Australian dollar/US dollar may see increased volatility unless new decisive macro or policy signals emerge.

Reporter Yuan Yuan

Text editing by Cheng Hui, Wang Zhexi