The pressure of having a strong Aussie dollar is rising to the surface at a time when the economy is trying to find its footing, and launch itself into the next market recovery. Back above $0.96 to the US dollar, a combination of factors is not letting the currency move toward its long-term average.
The Chinese economy, despite concerns earlier in the year, has been keeping up with the government's 7.5% GDP target, last month clocking in an annualised 7.8% increase. Exports in steel, for example, show that a market slowdown hasn't materialised as feared, and for that the Aussie dollar continues its climb back up, since a stronger Chinese economy means Australian exports will increase.
The RBA's decision to pause the interest rate cuts is also taken as a sign by forex traders that monetary woes are subsiding, and the economy doesn't need more pump-priming to move forward. Economic surveys are showing an improvement in business and consumer sentiment. With a cash target rate of 2.5%, the central bank believes it is at a tipping point, when any lower will encourage overheating in some sectors, like real estate.
Gainers from a strong currency are companies that buy imports and overseas services like The Reject Shop (ASX: TRS), Harvey Norman (ASX: HVN) and JB Hi-Fi (ASX: JBH). A higher dollar gives them more buying power, and higher profit margins. When the currency weakens, it increases their inventory costs, and with a weak economy they can't pass the higher prices to customers easily.
Fashion retailers like Premier Investments (ASX: PMV) and Specialty Fashion Group (ASX: SFH) are similar since much of their apparel is manufactured overseas.
Companies that will suffer from a higher currency are those that have to sell a comparatively higher foreign currency price just to get the same Aussie dollar. They lose cost competitiveness to rivals selling in cheaper currencies, and for those companies that produce overseas, their revenues and profits are reduced by translating the money values back into Aussie dollars.
Miners like BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO), Fortescue Metals Group (ASX: FMG) and New Hope Corporation (ASX: NHC) have millions less in profit for every cent the currency rises because their sales contracts are often based on US dollars, so if the US dollar becomes relatively weaker, then the companies report smaller earning.
Exporters and overseas manufacturers Cochlear (ASX: COH) and CSL (ASX: CSL) derive most of the revenue from overseas, so they will feel the stronger currency weighing down on their bottom line.
Foolish takeaway
The currency is reacting to stronger sentiment that the Australian economy is improving, so that is one thing to be thankful for. The problem is that other economies in Europe and North America are still either recovering or have only developed a soft base.
The US monetary woes from the GFC carried over into quantitative easing to boost money liquidity, but by the same token weakened its currency's relative value. Money flows like water through international banking, and as soon as foreign direct investors and forex traders sense a weakness in one market and strength in another, they slide funds accordingly.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
