If foreign exchange markets were guided purely by interest rate differentials, the Australian dollar should be pushing higher. The domestic economy is outperforming expectations, bond yields have climbed to levels not seen since early in the year, and markets are assigning a rising probability to another RBA rate hike in 2026. Meanwhile, the US Federal Reserve is preparing to ease.
Under normal conditions, this divergence should lift the current. Instead, the AUD remains stuck around US$0.65, behaving nothing like a currency with tightening ahead of it.
The mismatch between fundamentals and performance is now one of the more puzzling dynamics in global FX and it speaks to a deeper shift in how investors are interpreting risk, China, and the global macro narrative.
Rate Differentials Say One Things, The Market Is Doing Another
The three-year Australian government bond yield is back near 3.9%, the highest point since February. The two-year yield gap between Australia and the US, a classic driver of AUD direction, has blown out to 34 basis points, the widest gap since 2017. NAB’s Ray Attrill puts it plainly: based on rate spreads, the dollar should be well above its current level.
The RBA hasn’t just hinted at a tighter stance, the bond market is pricing a 58% chance of a rate hike in 2026, even as the Fed is moving in the opposite direction. Lower US yields should typically weaken the greenback and support commodity currencies like the AUD.
But FX markets aren’t trading the interest rate story right now.
Risk Sentiment Is Overpowering Fundamentals
The bigger force sitting on the AUD is global risk sentiment. The currency has long acted as a proxy for investor appetite, it allies when risk-taking expands and falls when markets anticipate stress.
Right now, markets are fixated on a different risk: a potential correction in US tech stocks, especially names tied to the AI boom. When global equity investors become cautious, the Australian dollar becomes a casualty.
This is the core tension that has pinned the AUD down: a fundamentally supportive domestic backdrop versus a global appetite for safety.
Every attempt the AUD makes to lift is quickly reversed as risk-off flows favour the US dollar.
China Remains the Structural Drag
The other headwind is China, still the largest external driver of Australian exports and, by extension, its currency.
Two issues are dominant:
- China’s property sector remains fragile: This sector is a major consumer of steel and thus iron ore, Australia’s single most important commdoity export. As long as property developers are struggling and construction is subdued, the market prices a structural drag into the AUD.
The currency market is pricing in a structural headwind for China property.
Oliver Levingston, Bank of America
2. Iron ore isn’t thriving: Even with upgraded forecasts, iron ore remains below its five-year average. Bank of America now sees US$95 a tonne by 2026 (up from US$80), but that’s still beneath the long-run average of US$118. Without a sustained recovery in China’s industrial activity, he AUD’s commodity tailwind remains muted.
The US Economy Is a Surprise Support for the Greenback
The US economy continues to outperform, and this is where the FX narrative diverges again.
Deutsche Bank strategist Lachlan Dynan trimmed his AUD forecasts for 2025 not because of China, but because the US economy is being supported by AI-driven investment. Stronger US growth gives markets fewer reasons to shift capital out of the USD, even with rate cuts looming.
This combination (strong US fundamentals + weaker China) has proven to be an unusually stubborn backdrop for the AUD.
Undervalued… But Possibly With Reason
Most FX strategists agree: the Australian dollar looks undervalued on paper. Dynan’s models put the fair value closer to US$0.68, and NAD’s fair value estimates aren’t far off.
Yet currency markets often trade beyond model value when structural uncertainties cloud the outlook. Today’s mix of global tech valuations, geopolitical tension and China worries is exactly that sort of environment.
In other words, the AUD may be cheap, but there’s a rationale behind the discount.
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What This Means for Investors
There are several takeaways for investors positioning around the AUD:
- Traditional rate differentials are not the dominant driver: The AUD is currently a sentiment asset more than a yield asset.
- China’s trajectory remains the swing factor: Until the property market stabilises or Beijing deploys larger-scale stimulus, the currency will struggle to outperform.
- The USD may stay stronger for longer: A resilient US economy pair with ongoing tech-sector optimism is keeping the USD well-supported.
- The AUD is coiled, but direction is dependent on global risk appetite: If markets stabilise and China shows signs of recovery, AUD/USD could break higher quickly. NAB expects a slow grind toward US$0.7, but that depends on risk turning.
The Australian dollar isn’t misbehaving. It’s reflecting a global macro environment where risk sentiment and China’s slowdown outweigh the traditional playbook of rate differentials.
The RBA may tighten before the Fed, but until markets turn risk-positive and China’s recovery becomes more than a forecast, the AUD’s upside will stay capped, no matter what the models say.