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Five implications of a lower $A

28 September 2014  |  Economics

FiveThe Australian dollar has finally begin to turn down. It probably has further to go, although only a fool would approach the currency markets with any level of confidence. The trade in the $A vastly exceeds its importance as a currency in trade or the world economy. It is the fifth or sixth most traded currency in the world for what is a relatively small economy. The $A is safe, underpinned by a government bond market that is more sound than most, and it offers proxy access to China because of the nation's heavy trade in commodities with that country.

There is little doubt that, on fundamentals, the $A is overvalued. The Trade Weighted Index (TWI) is about US70c, not US90c. It is likely that that is the "real" level for the currency, although there is little that is "real" in the global currency markets.

There are growing signs that it will be heading down. It recently fell to an eighth month low of 87 cents. There is, of course, the usual disagreement amongst economists:

 

"While many currency traders feel that a lower Australian dollar is inevitable in the next 12 months, the extent to which such falls will be realised in the short term remains highly debatable. Both ANZ and Westpac see the Australian dollar finishing the year close to US90¢. AMP chief economist Shane Oliver thinks it will be a year before the currency reaches US80¢.

“I know that everyone thinks [the US dollar is] going to be up and up and up, but I actually think we’re going to have another period of volatility towards the end of the year,” David Friedlander, partner at law firm King & Wood Mallesons told Channel Nine’s Financial Review Sunday program.

The M&A lawyer added that there were “bound to be some setbacks along the way?.?.?. Every time we have thought about the US economy improving, there’s been a setback.”

 

Take your pick.

Here is the graph:

 

 

What are some of the likely consequences? Here are a few possible implications for SMSF investors.

 

1. Foreign investors may start to dump Australian stocks, which will be worth less. But this does not necessarily happen. And at some point it will be more rational to buy.

2. Buying shares overseas is more expensive. This is a problem for DIY investors looking to diversify away from the Australian market.

3. The RBA may feel it has more room to raise interest rates. As can be seen in the graphic below, Australian bonds have performed better than in the US and there is also an interest rate differential (Australian interest rates are higher than American interest rates).

The RBA has not wanted to raise interest rates when it would increase that differential and lead, possibly, to an even higher currency. If the $A falls, they may feel freer to raise rates, especially as they are worried about the housing market becoming overheated.

4. Australian exporters will become more competitive. Enormous damage has been done to the nation's manufacturing base, so there will not be any quick turnaround, if there is a turnaround at all. But it certainly eases a lot of pressure if the currency continues to fall. It may at least stop the carnage.

5. Global companies, especially miners, will probably benefit. The supposedly high labour rates, about which there has been much complaining, are in part due to a soaring currency. That pressure may also ease.

 

 

 

 



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