02 9683 5999At 2318 AE DT on Friday, 15 October 2010 the Australian dollar reached parity with the US dollar for the first time since the currency was floated in 1983.
The 28-year high resulted in many Australians celebrating with “parity parties” resulting in a flurry of eager shoppers heading online to benefit from our stronger exchange rates and Australians moving the booking of a holiday to the US quickly to the top of their bucket lists.
Two reasons stand out as to why our currency is so strong:
- The first is that the Australian dollar comes with a substantial yield, and other countries would rather buy the high yielding Aussie dollar than the falling US dollar.
- The second being the US boosting the supply of its dollars in order to promote its exports and in turn lift its weakened economy. The result of increasing the supply of US dollars is that they fall in value. (It’s the old supply-v-demand theory).
The strength in the Australian dollar is also being given added drive by a combination of: 1. Rising commodity prices – they usually move inversely to the US dollar and their longer term trend higher is being driven by the commodity intensive demand in the emerging world. Commodities account for 70% of Australia’s exports and prices for virtually everything from coal to copper, from gold to wheat have soared over the last 18 months. 2. While the US and other major industrial countries are moving towards more monetary easing, the Reserve Bank of Australia looks set to raise interest rates and so further widen the difference in rates when compared with the US and other major countries. 3. The global financial crisis having improved the image of Australia to invest in by other countries.
However, some currency analysts warn not to pop the corks just yet, believing that our local currency is as much as 30 percent overvalued against the USD – based on the relative purchasing power in the two economies using an identical basket of goods.
Despite your views on whether our currency is fairly-valued or overvalued, a strong Australian dollar is neither a good or bad thing. As always, there are winners and losers. The main winners are consumers, provided with greater choice about where to take their holidays and where to buy their goods. Retailers and importers may win if they are able to pass only some, but not all of the savings.
Domestically manufactured goods are less competitively priced to sell abroad, and will have to compete with cheap imports at home. Australian companies that make their living in US dollars will be seeing a drop in income when they convert back to the local Australian currency. With around 30% of listed company earnings sourced overseas, a rise in the Aussie dollar will essentially cut potential earnings. Resource stocks, multinational industrials, steel makers and various health care stocks may lose from a rising AUD via the impact to their earnings.
For investors, the rise in the value of the Australian Dollar may not be good news as it will reduce the value of offshore investments, unless they are hedged. Global bond and property funds are usually hedged back to Australian dollars to remove the currency impact. Many Australian companies will utilise hedging strategies to insulate them from the currency fluctuations.
Investors need to take into account currency influences when assessing prospects for individual companies. But the key point is that the currency is just another influence. The main driver for company earnings is what the company does, how it is run and who it competes with. It’s important that investors don’t get too caught up with currency changes when making investment decisions.
Most of these effects from the strong AUD are overshadowing what would have otherwise been a picture of emerging health for corporate Australia, helped by a robust economy and low levels of debt. But we still have to realise that, whilst some are celebrating this currency landmark, the parity party hangover may be a bit tougher for some.
