How to trade the Australian dollar futures contracts

By | May 29, 2017
Australian Economy

The Australian dollar futures contracts are one of the ideal currency contracts to trade for a number of reasons. For starters, speculators and day traders who prefer to take exposure to a currency contract away from the Eurozone, Japan will find the Australian dollar futures contracts to be an ideal derivatives asset to trade.

To be successful in day trading the Australian dollar futures contracts one must focus on the fundamentals that influence the exchange rate. Here are some important things to know before you trade the Australian dollar futures contracts.

Economic Overview of Australia

Australia’s gross domestic product (GDP) for 2015 was close to $1.34 trillion USD.

Australia GDP 2015: 1.5 trillion USD

Australia GDP 2015: 1.5 trillion USD

The economy is relatively small, but on a per capita basis is comparable to many industrialized Western European countries. Australia has a service-oriented economy with close to 79 percent of its GDP coming from industries such as finance, property and business services.

However, the country has a trade deficit, with manufacturing dominating its exporting activities. Rural and mineral exports account for over 60 percent of all manufacturing exports. As a result, the economy is highly sensitive to changes in commodity prices.

Japan and the ASEAN (Association of Southeast Asian Nations) are the leading importers of Australian goods. In the past, however, Australia has experienced much of the spillover effects of general Asian weakness. This resilience stems from Australia’s sound foundation of strong domestic consumer consumption.

Monetary & Fiscal Policy

The Reserve Bank of Australia (RBA) is responsible for the monetary policy of Australia. Decisions on monetary policy are based upon consensus within the committee.

The RBA’s charter states that the mandate of the Reserve Bank Board is to focus monetary and banking policy to help ensure:

  • the stability of the currency of Australia;
  • the maintenance of full employment in Australia; and
  • the economic prosperity and welfare of the people of Australia.

In order to achieve these objectives, the government has set an informal consumer price inflation target of 2 to3 percent per year.

The RBA’s monetary policy decisions include setting interest rates on overnight loans in the money market.

Other interest rates are influenced by this overnight cash rate to varying degrees so that the behavior of borrowers and lenders in the financial markets is affected by monetary policy (though not only by monetary policy).

Through these channels, monetary policy affects the economy in pursuit of the goals outlined above.

Overnight Cash rate

This is the RBA’s target rate for open market operations. The cash rate is the rate charged on overnight loans between financial intermediaries. As a result, the cash rate should have a close relationship with the prevailing money market interest rates. Changes in monetary policy directly affect the interest rate structure of the financial system.

Open market operations

The focus of daily open market operations is to keep the cash rate close to the target by managing money market liquidity provided to commercial banks.

If the Reserve Bank wishes to decrease the cash rate, they would increase supply of short-dated repurchase agreements at a lower interest rate than the prevailing cash rate, which would in essence, decrease the cash rate.

If the Reserve Bank wishes to increase the cash rate, they would decrease supply of short-dated repurchase agreements, which would in essence increase the cash rate.

How does a repo agreement work?

A repurchase agreement involves a cash taker (commercial bank) selling securities to a cash provider (RBA) while agreeing to repurchase the securities of the same type and quantity at a later date.

This structure is similar to a secured loan whereby the cash taker must pay the cash provider interest. These repo transactions tend to have very short maturities ranging from one day to a few weeks.

Since 1983, Australia has had a floating exchange rate. The Reserve Bank of Australia may undertake foreign exchange market operations when the market threatens to become excessively volatile or when the exchange rate is clearly inconsistent with underlying economic fundamentals.

RBA Trade Weighted Index for the AUD

RBA Trade Weighted Index for the AUD

The RBA monitors a trade-weighted index (TWI) as well as the cross-rate with the U.S. dollar. Intervention operations are invariably aimed at stabilizing market conditions rather than meeting exchange rate targets.

When does the RBA meet to set interest rates?

The RBA meets every month (except for January), on the first Tuesday of each month to discuss potential changes in monetary policy. Following each meeting, the RBA issues a press release outlining justifications for their monetary policy changes.

They also publish a monthly Reserve Bank Bulletin. The May and November issues of the Reserve Bank Bulletin include the Semi-Annual statement on the Conduct of Monetary Policy.

The February, May, August, and November issues contain a Quarterly Report on the Economy and Financial Markets. It is important to read these bulletins for signals on potential monetary policy changes.

How to trade the Australian dollar futures contracts – Characteristics

Commodity-linked currency: The AUD$ has an 80 percent correlation with commodities and more specifically, gold prices. Its link to gold stems from Australia being the third largest gold producer in the world and represents approximately $5 billion in exports for the nation each year.

As a result, the AUD$ benefits when commodity prices increase. Of course, it also decreases when commodity prices decline.

Carry trade effects: Australia has one of highest interest rates among the developed countries. With a fairly liquid currency, the AUD$ is one of the most popular currencies to buy for carry trades.

You can also follow the interest rate differentials between the cash rate of Australia and the short term interest rate yields for other industrialized countries.

Interest rate differentials are a good indicator of potential money flows into a country. They dictate how much yield premium the Australian dollar denominated fixed income assets can demand. In most cases it is all about the difference in the offering: the foreign short-term fixed income asset and so on.

This differential provides traders with indications of potential currency movements, as investors are always looking for assets with the highest yields

Influence of weather on the Australian economy: Since the bulk of Australia’s exports are commodities, the country’s GDP is highly sensitive to severe weather conditions that may damage the country’s farming activities. This is especially important because agriculture accounts for 3 percent of the country’s GDP.

The RBA estimates that the “decline in farm production could directly reduce GDP growth by around 1 percentage point.” Aside from exporting activities, a drought also has indirect effects on industries that supply and service agriculture.

Important Economic Indicators for Australia

  • Gross Domestic Product (GDP)
  • Consumer Price Inflation (CPI)
  • Balance of Goods and Services
  • Private Consumption
  • Producer Price Index (PPI)

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