The US Federal Reserve is not Australia’s central bank, but you would be forgiven for thinking otherwise. When the Fed raises or lowers interest rates, adjusts its balance sheet, or even changes the tone of its forward guidance, the effects ripple across the Pacific and land squarely in Australian financial markets.

Understanding this relationship is essential for anyone who follows the Australian dollar, trades forex, or runs a business with international exposure.

Why the Fed Matters So Much

The US dollar is the world’s reserve currency. Roughly 88 per cent of all foreign exchange transactions involve the greenback on one side. Commodities — including the iron ore, coal, and natural gas that underpin Australia’s export economy — are priced in US dollars. Global capital flows are heavily influenced by US interest rates.

This means the Fed’s monetary policy decisions do not stay within American borders. They set the tone for global financial conditions. When the Fed tightens policy by raising rates, it strengthens the US dollar, attracts capital toward US assets, and tightens financial conditions worldwide. When it eases, the opposite tends to happen.

The AUD/USD Connection

The Australian dollar’s most watched exchange rate is against the US dollar. The AUD/USD pair is one of the most liquid in the world and is highly sensitive to the interest rate differential between the two countries.

When US rates are high relative to Australian rates, investors can earn a better return holding US dollar assets. This draws capital away from Australia and puts downward pressure on the AUD. When the gap narrows — either because the Fed cuts or the RBA raises — the AUD tends to strengthen.

Over the past two years, this dynamic has been front and centre. The Fed’s aggressive tightening cycle, which pushed the federal funds rate above five per cent, widened the gap with Australian rates and contributed to sustained AUD weakness against the greenback.

Beyond Interest Rates: Risk Sentiment

The Fed also influences the AUD through a less direct but equally important channel: global risk appetite. The Australian dollar is often described as a “risk currency” because it tends to rise when investors are confident and fall when they are nervous.

Fed policy affects risk sentiment in several ways. Hawkish surprises — tighter policy than expected — can trigger sell-offs in equities and risk assets, dragging the AUD down even if Australian economic conditions are solid. Dovish surprises can lift risk appetite and push the AUD higher.

This is why currency traders in Sydney pay just as much attention to Fed Chair Jerome Powell’s press conferences as they do to RBA Governor Michele Bullock’s statements. A single phrase — “data dependent,” “higher for longer,” “prepared to act” — can move markets within seconds.

The Commodity Channel

Australia is a major commodity exporter, and commodity prices are denominated in US dollars. When the Fed’s actions strengthen the US dollar, it can push commodity prices lower in dollar terms. This reduces the value of Australia’s exports and weakens the terms of trade, which in turn weighs on the AUD.

The relationship is not mechanical — commodity prices are influenced by supply, demand, and geopolitical factors as well — but the US dollar’s gravitational pull on commodity markets is a persistent force that shapes Australia’s economic fortunes.

Practical Implications

For Australian businesses trading internationally, Fed policy is a variable that cannot be ignored. A company importing goods priced in US dollars faces higher costs when the Fed is hawkish and the US dollar is strong. An exporter receiving US dollar revenues benefits from the same scenario but faces margin pressure when the Fed eases and the greenback weakens.

Hedging strategies need to account for both RBA and Fed policy paths. A business that only watches domestic interest rates is seeing half the picture. The most effective currency risk management considers the interplay between the two central banks and positions accordingly.

For investors, the Fed’s influence extends to equity markets, bond markets, and property. Australian bank funding costs are linked to global credit markets, which the Fed heavily influences. Even the local housing market, through its connection to mortgage rates and bank funding, is not immune to what happens in Washington.

Looking Ahead

As we move through late 2025 and into 2026, the Fed’s next moves remain a matter of intense debate. Markets are pricing in the possibility of rate cuts, but the timing and magnitude are uncertain. Any deviation from expectations — in either direction — will reverberate through the AUD and Australian financial markets.

The key takeaway is simple: the Fed matters for Australia, perhaps more than any other external institution. Ignoring its decisions is not an option for anyone with exposure to currency markets, international trade, or global investment flows. Staying informed about Fed policy is not a luxury; it is a necessity.