What would happen to the AUD/USD if the US raised interest rates? (1 Viewer)

[seremify007]

Apparently this question was asked in some IB interviews this year, and I'm curious to hear what the guys on BoS think.

When I was asked my view on this, I had two conflicting thoughts- the first being the textbook theory of interest rate parity and interest rate differentials (in short, AUD/USD falls as a result of it being less attractive for investors), the second being a more modern school of thought regarding confidence in local and international economic conditions (in short, AUD/USD rises in response to increased economic confidence likely to stimulate demand for Aussie exports).

Thoughts?

 

[michaeljennings]

I only know what the textbook tells me lol so Id go with the first scenario you described where AUD/USD falls. But real life doesnt always follow theory so I can understand people thinking the second scenario is correct.

 

[seremify007]

Apparently the interviewers were looking for the 2nd response as the 'answer'. *shrugs* If it were me in the interview I'd caveat my answer with "textbook theory suggests...., but practically speaking, it would signal increased economic confidence in the US economy to the global markets".

 

[DeltaZero]

Not sure why you would say a rate hike would signal increased economic confidence. I would say the very opposite, a rate increase by Bernanke will send very negative shockwaves throughout the global financial system.

Think about it: Europe is getting screwed harder than the village bicycle. The US is burdened with debt, its growth rate is a paltry 1.3% and stagnating there, and its unemployment is refusing to fall below 9%. The Fed has already tried everything it can, the rate is already at a historic low of 0-0.25% and QE2 wasn't very effective. If they decide to raise rates, it would effectively choke off any hope of an economic recovery and could quite likely cause the US to fall into a double dip recession.

Investors will be shocked and confused as to why Bernanke would follow such a course of action. They will undoubtedly suffer from a flight to quality. Money will flood into Treasuries, gold, and potentially the safe haven currencies (not sure what the BOJ and Swiss policies on intervention are, and if they still have a hard cap on). Equities will drop like early August. Volatility will spike like crazy again.

The Aussie is perceived to be a proxy for risky assets and commodities, and also as a play for Asian currencies. In a risk off scenario, nobody will want to hold risky assets. Furthermore investors will forecast either a global recession or at least an extended period of very modest growth, either way commodities will see a fall in demand. As a result the Aussie will be savaged, maybe falling past 95c. Look what happened every time there was a scare in the markets in the past 3 years.