Rally in the Australian Dollar; a Double-Edged Sword
- Increase in AUD complicating RBA interest rate policy.
- Consumer Discretionary benefitting from strong AUD.
- US exposed businesses struggling based on falling USD.
Since October 2020, the Australian dollar has rallied by approximately 10 per cent against the US Dollar. This has created a macroeconomic story which is supportive for a wide array of businesses but also rotates foreign exchange benefits away from other businesses.
A strong economy attracts overseas investors to buy the country’s currency. Unfortunately for America, the strength of the economy has been in question for some time, which has been reflected in the currency strength since November. The dollar index fell around 5 per cent in this timeframe.
COVID-19 impacts, along with interest rate cuts, political instability, consumer sentiment, GDP and foreign relation troubles have all had their own influence on the US Dollar and created an environment for certain types of businesses to do well. This includes companies that import product from overseas and sell them within Australia, benefitting from the strengthened Australian dollar. Conversely, Australian businesses that have bases in America would be the most negatively affected by this trend, as they must contend with weaker profits as the currency that buys and sells the company goods and services is weaker than before.
The consumer discretionary sector should benefit from this environment as many businesses within the sector import goods from overseas and sell their products within Australia. It must be noted however, that despite having foreign exchange rates supporting the sector, this doesn’t necessarily mean that every business in the sector will benefit due to the idiosyncrasies of each business in the sector.
Examples of local businesses who belong to this category include Kogan.com, Super Retail Group and Breville. These stocks have all been on bullish runs as of the 6th of January, on the back of their business performance but supported by positive Australian dollar action.
On the other hand, businesses such as CSL, Cochlear, Resmed and Appen have been negatively influenced by the US Dollar, with exposure to America. It must be noted however that this is only one factor affecting these companies and resiliency can be found in the fundamentals and sentiment surrounding quality businesses. Gold producers in Australia will also be affected by the change in currency, as gold is traded in US dollars. Yet other factors such as rising prices of gold must also be considered for these businesses.
Another common monetary policy tool adopted by central banks is cutting interest rates; meant to encourage more borrowing. This aims at increasing spending and promoting a healthy economy. The rising Australian dollar makes this outcome harder to achieve because when these loans are paid back, the borrower is paying back more than the expected value. The decrease in interest rates has made government bonds less attractive as a by-product, promoting investment in higher returning asset classes.
Depending on how these factors play out between central banks, governments, and economic performance; currency fluctuation can act as a favourable environment for some Australian businesses to flourish. Awareness of the interaction between how equities are influenced by commodities, currencies and interest rates can reveal opportunities otherwise missed.
More for you
ARB Corporation Releases Positive Trading Update
- 12 January 2021