In 2010 the Australian dollar reached parity with the US greenback for the first time since it was floated in 1983. In 2011, the dollar looks set to continue its rally. Two senior strategists from BT Investment Management (BTIM) explain the rise of the Australian dollar.
- How will parity and above impact investments?
- 3-6 month outlook
Cameron Fouladi, BTIM’s Senior Portfolio Manager for Macro Strategies, has closely monitored the rise and fall of the Australian dollar along with other world currencies, right through the dark days of the Global Financial Crisis (GFC) in 2008/2009. Since its low point in February 2009, he says the Aussie dollar has gone from strength to strength.
“Before the GFC the Australian dollar was trading at around 94c against the greenback, but when the crisis hit, it dropped to around 63c as investors fled to the security of the US dollar. As the GFC deepened the Reserve Bank of Australia (in concert with other central banks) cut interest rates sharply, further weakening the Aussie dollar. When the crisis abated Australia emerged relatively unscathed from the GFC and, in late 2009, the RBA became one of the first central banks to begin raising its interest rates. Since then the Aussie dollar has appreciated to the point where it has now recaptured all of its losses.”
Aussie to maintain strong position in 2011
Looking into 2011, Mr Fouladi sees the Aussie dollar maintaining its position above the greenback. “Australia has high interest rates compared to other countries around the world, which is a positive for our currency, as well as demand for Australian goods and raw materials from countries like China. I believe this will see the Aussie dollar go through parity in the longer term, perhaps as high as $1.10.”
The recent second round of ‘Quantitative Easing’ or ‘QE’ (economist speak for money printing) by the US Federal Reserve, is also expected to be supportive of the Aussie dollar, according to Joe Bracken, BTIM’s Head of Macro Strategies.
“QE works by injecting money into the economy. The US government, through purchases of bonds, puts money into the banks which can then be loaned to the public. Consequently, and despite reluctance in the past, banks are now starting to relax their lending constraints and money is flowing into important areas like small to medium enterprises which employ a large number of people and make up a significant part of the US economy. However one of the consequences of QE is that the increase in the supply of US dollars may weaken the currency causing further appreciation of the Australian dollar”.
Mr Bracken notes that while QE may cause the US dollar to fall he believes this weakness will be short-lived. “Once the US economy picks up, it will lead to a rise in the US dollar as currency follows the economy. If the US Federal Reserve hadn’t taken QE action, we’d probably still be in a nasty recession and the GFC would have gone on for a lot longer than people realise”.
How will the stronger Aussie dollar impact on domestic and international investments, including hedged investments?
While the strong Aussie dollar is good for Australian importers and holidaymakers heading overseas, exporters should expect to be more prudent in managing their currency risk. However, Mr Fouladi does not see the higher Australian dollar adversely affecting the local mining industry, which he believes will be sustained by healthy profit margins. The Aussie dollar’s strength also presents Australian investors with a good opportunity to invest overseas, he says. “If you are an Australian investor, a stronger dollar makes the idea of picking up international assets more attractive because they are cheaper on a relative basis.” Indeed, right now local investors can pick up US shares on almost a dollar for dollar basis. It’s possible to invest directly (through a broker offering access to international shares) although a simpler option is an international share fund. It’s worth noting however that while a strong Aussie dollar boosts our ability to buy international investments, it can also wipe out some of the gains once the returns are converted back to local currency. Just as the value of imports falls when the dollar rises, so too do returns from offshore assets once they’re converted back to Australian dollars.
Hedging to avoid currency fluctuations
It is possible to avoid the effect of currency fluctuations by hedging an investment and this option is offered by many international share funds. Put simply, hedging means the fund employs strategies (such as using currency derivatives) to protect the fund from unwanted moves in exchange rates. Be mindful there are fees for hedging, which can impact returns. On the other hand, like any form of risk reduction, hedging may soften the blow in the event exchange rates move dramatically (as seen in 2008/2009). Currency movements have always been hard to predict but in today’s climate of global economic uncertainty, estimating the future direction of the Aussie dollar is even more challenging. This can make it worth having an ‘each way’ bet by dividing your international investment between hedged and unhedged international share funds. As most fund managers offer both fund options, this allows investors to tap into the strong buying power of our dollar while capping the downside of potentially weaker, ongoing returns.
What is the outlook for the next 3–6 months?
More struggles ahead for the Euro: The sovereign risk in the Euro’s peripheral countries like Greece, Portugal, Spain and Ireland, and the difficulties of managing a currency across a range of different economies signals more hurt ahead for the Euro.
Aussie dollar continues to show value: The Australian dollar is a quality blue chip currency, with the banks and economy in good shape and strong growth potential through our trade with China.
A slow return to form for the US dollar: Rising yields in the US bond market show some expectations of inflation and growth, which will be a positive for the US dollar and US assets.