Australia’s terms of trade — the ratio of export prices to import prices — have been quietly deteriorating for 18 months, and the trend matters more for AUD than most market commentary acknowledges. While everyone focuses on RBA rates and Fed decisions, the terms of trade tell a story about structural buying power that feeds into the currency over longer timeframes.

The December quarter national accounts showed the terms of trade falling 3.2% quarter-on-quarter, the fourth consecutive decline. They’re now about 22% below the mid-2022 peak when coal and LNG prices were at extraordinary levels during the European energy crisis. Some reversion was inevitable. But the current trajectory has taken them below the pre-COVID average, suggesting this isn’t just normalisation — it’s a genuine headwind.

What’s Driving the Decline

Iron ore and coal dominate Australia’s export basket, accounting for roughly 45% of total goods exports by value. Both have been falling.

Iron ore has dropped from above $130/tonne in January 2025 to around $100 currently. Chinese property construction remains depressed, steel production has plateaued, and supply from Brazil and Guinea is gradually increasing.

Newcastle benchmark thermal coal has settled around $110-120/tonne after spiking above $400 in late 2022. European gas storage remains comfortable and renewable energy continues eating into coal demand.

On the import side, prices have been relatively stable, so the denominator hasn’t helped offset the numerator decline.

How This Hits AUD

The most direct channel is the current account. Falling export prices reduce demand for AUD from foreign commodity buyers. Australia ran a goods trade surplus of about $5.6 billion in January 2026, down from surpluses exceeding $12 billion per month during the commodity peak.

The second channel is national income. Lower terms of trade reduce real purchasing power even if GDP volume growth is maintained. The national accounts showed real gross national income falling 0.4% in Q4 2025 despite real GDP growing 0.3%. That divergence is the direct consequence of deteriorating terms of trade.

The third channel is market positioning. Large macro funds track Australia’s terms of trade as a valuation anchor for AUD. When the terms of trade deteriorate, AUD tends to trade at a discount to what rate differentials alone suggest.

Historical Context

Over the past 20 years, the terms of trade have correlated with AUD/USD over 2-3 year horizons. The last time they were at current levels — late 2020 — AUD/USD was trading 0.70-0.78, well above today’s 0.63.

But you can’t simply map terms of trade onto the exchange rate. In 2020-2021, the Fed had rates near zero and the USD was broadly weak. Today, the Fed funds rate is 4.25% and the dollar is firm. Adjusted for the rate differential, the terms of trade suggest AUD/USD is roughly fairly valued around 0.63-0.65. That’s a different conclusion than the terms of trade alone would suggest.

What Could Stabilise Things

The bull case needs at least one of: a genuine Chinese property recovery driving iron ore demand; coal prices finding a floor from tighter energy markets; or emerging exports like lithium and copper gaining enough scale to matter (still years away at current trajectories).

Brent crude hovering around $78/barrel limits scope for import price declines that could help from the other side.

What I’m Watching for Q2

If iron ore holds above $95 and coal stays near $110, the Q1 terms of trade decline will be modest — perhaps 1-2% quarter-on-quarter. That’s manageable. If iron ore breaks below $90 on disappointing Chinese property data, AUD/USD probably retests 0.61-0.62.

The February trade data (released in April) will show whether export volumes are offsetting price declines. Volume data has been solid — iron ore shipments from Port Hedland hit a record in January. But volume can only compensate for so much price decline.

For now, the terms of trade are a steady headwind rather than an acute crisis. They’re keeping AUD from rallying even when short-term sentiment improves — like a drag anchor on a boat. The engine might push forward occasionally, but the anchor limits the distance. Until commodity prices stabilise, that drag on AUD isn’t going away.