Pinball Currency

Watch the Australian Dollar for more than holiday planning.

The Australian Dollar (AU$) is the ¹fifth most traded currency globally and one of the ²most volatile currencies for a developed country. The AU$ ricochets from local economic news, international events such as US and Chinese trade talks and Brexit and global demand for commodities.

That’s a lot for one currency.

Beyond planning for overseas holidays, investors may glean useful information from changes in the AU$. The value of the AU$ may;

• Affect the prospects for a range of local companies;
• Reveal expectations about the global economy; and
• Reflect the market’s estimates of future interest rate activity.

More than Mining

To recap some underlying market factors, generally;

• Importers and Australians wanting to travel to another country prosper from a strong AU$ (the same amount of AU$ buys more overseas);
• Exporters and local tourism operators prefer a weak AU$ (the price of goods and services is lower for buyers with a stronger foreign currency);
• Like the exporter, a company with profitable operations offshore will benefit from a weaker AU$ when it brings money back home.

Investors might reasonably conclude that Australian mining companies, as exporters of commodities, prefer a weaker AU$. But a weak AU$ may also indicate lower global demand, hence a lower price, for Australian mining products. Thus, some investors might conclude that a weaker AU$ means the value of mining company shares will fall as commodity prices fall.

Exasperatingly, mining company shares can go either up or down in response to a weaker AU$. Investors need to identify the driver behind any change in the AU$ – changes may not reflect global demand for commodities.

It is worth remembering that most commodities trade in US$. As a result, some Australian mining companies report their earnings in US$.

If a company that reports earnings in US$ announces a dividend, typically that dividend will be in US$. Australian investors can benefit if the AU$ is weaker when any US$ dividends are converted and paid in AU$.

Mining companies are not the only Australian companies that report earnings in US$. Also, other Australian companies earn money from offshore operations. Understanding the drivers behind currency moves may help investors forecast the economic prospects of such companies.

Relative Interest

Generally, a country with higher interest rates than other countries will tend to have a stronger currency as foreign investors convert money to earn the higher rate.

Interest rates in Australia are low at the moment, but interest rates in some developed countries are lower still (and, in some cases, below zero). Investors might reasonably conclude that this relative difference in interest rates means a strong AU$. But there are more factors to consider.

If global investors become worried about risk, they tend to switch to supposedly safe investment havens such as America. Any weakness in the AU$, relative to the US$, may indicate market concerns about the global economic outlook.

The Reserve Bank recently suggested the Australian economy has reached ³a gentle turning point meaning further interest rate cuts may be unnecessary. If interest rates in other countries remain low then, by maintaining our interest rates, the AU$ may find support.

Some market commentators take the opposite view of the economy and believe it will require more stimulus. If interest rates reach zero, the Reserve Bank may need to use quantitative easing (QE). The Reserve Bank could implement QE several ways; ranging from a cash handout to households to buying Government-issued bonds.

One QE method is for the Reserve Bank to buy US$ (selling AU$) to weaken the currency to support exporters. In the past, the Reserve Bank was reluctant to deal in currency markets, meaning such a direct QE intervention is unlikely. But other QE methods, if implemented, can impact the currency. Whether the AU$ will go up or down depends on how any QE is implemented.

Opportunities Exist

Some people attach a sense of national pride to the strength of their currency.
Whether the AU$ is falling or rising, the key is to understand what drives the change to uncover potential opportunities.

A margin loan may be a way for suitable investors to take advantage of opportunities or to invest in a range of international shares.

If you have any questions or would like to discuss your loan account, please get in touch with your Relationship Manager, or contact Leveraged on 1300 307 807.

This information is correct as at 7 November 2019.

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