The Australian dollar versus the US dollar exchange rate faces several headwinds in 2025.  Currently trading near multi-year lows, this currency pair reflects multiple global economic factors that challenge market forecasters. The NAB FX strategy team indicate that while short-term pressures may persist, moderate appreciation could materialise later in the year, though numerous variables could influence this trajectory.

Current Performance and Short-Term Outlook

The AUD/USD commenced 2025 at approximately 0.6150 in January, hovering near five-year lows due to sustained US dollar strength bolstered by robust US economic indicators. Meanwhile, uncertainties regarding China’s economic performance and the potential impact on mineral prices exerted downward pressure on the AUD. By early March, a modest recovery to 0.6350 occurred, though market sentiment remains predominantly cautious.

The NAB FX strategy team project stabilisation around 0.65 mid-year with potential movement toward 0.67 by December. However, substantial downside risk exists.  Currency strategists acknowledge the possibility of sub-0.60 levels should specific risk scenarios materialise, particularly regarding Chinese economic performance or unanticipated US Federal Reserve policy adjustments. While it is not our base case there are a few key factors to keep an eye on through the year.

Key Determinants for 2025

Monetary Policy Divergence: Reserve Bank of Australia vs. Federal Reserve

The interest rate differential between Australia and the United States represents a fundamental driver for AUD/USD fluctuations throughout 2025.

The Reserve Bank of Australia (RBA) made its first rate cut in February 2025, marking the first reduction since November 2020, over four years ago.  It is anticipated to implement additional monetary easing by mid-year as inflation moderates and growth considerations become paramount. Futures markets indicate approximately two more interest rate cuts by November, potentially reducing the cash rate from 4.1% to approximately 3.60%. This dovish orientation contrasts markedly with the previous year’s policy stability.

Conversely, Federal Reserve officials have adopted a more measured approach following 100 basis points of reductions last year. With upward revisions to US growth forecasts and persistent inflationary pressures, the narrowing interest rate differential creates an unfavourable environment for the Australian dollar. Real rate differentials currently trend against the AUD, historically a reliable indicator of currency depreciation.

Geopolitical and Trade Considerations

The current US administration’s trade policies have reintroduced uncertainty into global markets. Tariff implementations targeting imports from China, Mexico, and Canada not only strengthen the US dollar but also create cascading effects for Australia’s export-oriented economy.

China’s potential monetary policy response and potential retaliatory tariffs warrant particular attention. Should Beijing permit yuan depreciation in response to US tariffs—a pattern observed intermittently—the AUD faces additional downward pressure given its correlation with Chinese economic indicators.

This presents material risk for Australia, where China represents over 30% of export volume. Any significant reduction in Chinese demand for iron ore, coal, or agricultural commodities would heighten currency vulnerabilities.

Commodity Market Dynamics

Australia’s economic performance remains intrinsically linked to commodity markets, with iron ore pricing serving as a critical indicator for trade balance outcomes and subsequent currency valuation.

While iron ore prices have shown modest declines this year, pressured by trade tensions with China which have been partly offset by lower production from Brazil due to supply constraints. However, looking forward pricing risk remains, particularly if subdued Chinese construction activity continues.

Potential for Second-Half Recovery

Despite challenging first-half conditions, several factors could facilitate AUD appreciation in the latter half of 2025:

– Chinese Economic Stimulus: Historical precedent suggests Beijing implements fiscal expansion when growth indicators fall below target thresholds. Recent official communications indicate increasing policymaker concern, enhancing the probability of substantial support measures that would benefit Australian resource exports.

– US Dollar Momentum Reversal: Currency trends inevitably shift. Should US economic performance moderate beyond expectations or fiscal policies generate unanticipated headwinds, the dollar’s extended appreciation cycle could terminate.

– Australian Economic Resilience: Despite external pressures, Australia’s economy has demonstrated significant adaptability. Labor market indicators continue to exceed projections, and consumer expenditure, though constrained, has not contracted substantially despite elevated interest rates.

Institutional projections from our currency analysis department indicate potential AUD/USD valuations of 0.65 by June and approximately 0.67 by year-end, contingent upon global economic stabilisation and the absence of escalating trade tensions.

Risk Factors Requiring Monitoring

While recovery scenarios exist, several downside risks warrant vigilant observation:

1. Chinese Economic Trajectory: A pronounced deceleration in Chinese economic activity would disproportionately impact Australia’s export sectors. Recent manufacturing data has underperformed expectations, while property market conditions remain tenuous despite policy interventions.
2. US Dollar Resilience: Continued US economic outperformance relative to global counterparts or increased safe-haven capital flows due to geopolitical instability could extend dollar appreciation against most currencies, including the Australian dollar.
3. Monetary Policy Efficacy: While rate reductions aim to stimulate economic activity, their effectiveness is not guaranteed. Should monetary easing fail to generate meaningful growth or inflation prove persistent, confidence in Australia’s policy framework could deteriorate.
4. Commodity Supply Disruptions: Global supply chains remain susceptible to geopolitical tensions and climatological events. Significant disruptions affecting key Australian exports could induce heightened currency volatility.

Implications for Fixed Income Investments

The AUD/USD outlook carries significant consequences for fixed income portfolio management, presenting distinct risks and opportunities:

USD-Denominated Australian Corporate Debt

Australian corporations issuing USD-denominated liabilities can face additional currency risks compared to borrowing locally. Australian corporates regularly issue debt in other regions with three main motivators:

1)  Capitalise on lower borrowing costs compared to borrowing in AUD

2) Diversify the geography of their investor base

3) Borrow in a currency that matches the revenue currency (resource companies for example generate revenue primarily in USD)

An issuer that generates most of its revenue in AUD, such as a major Australian bank, would utilise a hedging instrument like a cross-currency swap to convert the foreign loan principal and foreign coupons into AUD for the duration of the loan term. This effectively manages both currency and interest rate risk for the bank.

However, a resource company such as BHP, who generates revenue mostly in USD, could manage the interest rate risk on a USD bond issue by using a USD interest rate swap, and keep the loan principal and coupons in USD.

Significant movements in currency can have a significant impact on the profitability and balance sheet strength of a corporate. For a bond investor, a negative credit impact or outlook due to currency risk may impact the credit rating for a company and by extension the price the company pays for their debt.

From a bond investor’s perspective, the opportunity to generate additional returns from investing in foreign denominated bonds needs to be weighed up against the potential currency risk impacting coupons and principal. For example, a major Australian bank may have a USD bond on issue that provides a higher yield in that market because name recognition is lower in the US compared to Australia. A local bond investor could look to capitalise on the higher US yield bank by selling Australian dollars and buying US dollar and purchase the USD bank bond. If the investor bought at the current exchange rate of 63c, they may face substantial losses when converting future coupons and the loan principal back to AUD if the currency moved higher, as NAB is forecasting.

Undertaking a currency hedge to lock in the AUD/USD exchange rate for future USD coupons and USD principal could provide a superior outcome as opposed to remaining unhedged. However, an investor who maintains USD currency holdings may not be concerned about movements in AUD/USD if they prefer to keep coupons and principal in USD.

Currency-Hedged Fixed Income Strategies

Hedging costs for AUD/USD exposure have shifted significantly, reflecting evolving interest rate differentials between both economies. Twelve-month forward points have contracted from approximately 180 basis points in early 2024 to 120 basis points currently, reducing hedging expenses for USD investors in AUD-denominated securities.

This evolution creates tactical opportunities for globally diversified fixed income portfolios. Currency-hedged Australian bonds present potentially favourable risk-adjusted returns compared to equivalent USD credit instruments should our Analyst FX forecast materialise.

AUD-Denominated Investments for International Investors

For USD-based investors holding AUD-denominated securities, currency translation effects have substantially reduced returns since 2022. Instruments yielding 4.5% in AUD terms would have generated negative total returns when converted to USD, reflecting approximately 8% AUD/USD depreciation over twelve months.

Current valuation levels present potentially favourable entry points. With Australian yields maintaining relative attractiveness and potential currency stabilisation, selective opportunities exist for USD investors to secure both yield advantages and potential currency appreciation should our second-half recovery scenario materialise.

Kangaroo Bond Market Dynamics

The Kangaroo bond market—comprising AUD-denominated instruments issued by non-Australian entities—has experienced a 22% year-over-year issuance reduction as currency volatility complicates pricing mechanisms. In the financial sector, strong offshore brand names such as BNP Paribas, HSBC, Lloyds Bank and Rabobank issue in the Australian bond market to maintain an investor base in this region.

For investors with medium-term expectations of AUD appreciation, these market dynamics could present potentially advantageous entry points, particularly for debt instruments issued by highly rated organisations and European financial institutions.

Conclusion

The AUD/USD outlook for 2025 reflects multiple domestic and international economic variables. While near-term pressures will likely constrain the pair through the first half, potential exists for moderate appreciation as the year progresses, contingent upon global economic stabilisation and narrowing monetary policy divergence.

For institutional investors and corporate entities, continuous monitoring of RBA and Federal Reserve policy developments, US-China trade dynamics, and Chinese economic indicators remains imperative. Market participants capable of accurately interpreting evolving conditions and implementing appropriate strategic adjustments will be optimally positioned to navigate—and potentially capitalise on—prevailing market volatility.

The Australian dollar’s trajectory will not follow a linear progression, but strategic opportunities exist for entities maintaining a forward-looking perspective.

This article first appeared in FS Advice 

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This article has been prepared by NAB.  The information contained in this article is believed to be reliable as at March 2025 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. ©2025 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.