There has been plenty of speculation regarding the Australian dollar this year, with various estimates floating around about how much it is really worth.
While one analyst suggested just last month that the dollar could trend as low as US 40 cents, it has actually risen in the time since. From around US 74 cents, one Australian dollar is now buying US 76.33 cents with some suggesting it could rise higher – at least in the near term.
This is partially a result of Brexit. Allow me to explain…
What drives the Australian dollar?
The direction of the Australian dollar depends largely on three things, all of which have contributed to its sharp movements so far this year.
- The Australian economy: things such as employment, inflation or housing data, as well as business and consumer confidence can indicate where the economy is headed, and how much growth to expect. Yesterday's monthly employment data wasn't as strong as economists had hoped for, but a lift in full-time positions helped to propel the dollar higher.
- Commodity prices: Much of Australia's tax revenue comes from the commodities sector, which in turn relies on higher commodity prices to grow earnings. Iron ore is particularly important as a commodity, and that has rebounded strongly in recent months.
- Interest rates: In this globalised economy, investors from around the world seek the highest returns. Although Australia's cash rate is sitting at a record low 1.75%, it is still well above the interest rates offered in most other established economies around the world. The lack of easing bias introduced by the RBA at their July meeting may have improved investor confidence that rates will be left where they are as opposed to being lowered any further.
So, where does Brexit come into all this?
Although it was always expected to be a close vote, Britain wasn't expected to actually vote to leave the European Union. Its decision has thrown markets into disarray, spreading panic and uncertainty through the global economy.
Ironically, however, markets have actually responded positively in the time since. This is mostly due to expectations that the heightened uncertainty will prompt central banks around the world into action, lowering interest rates to stimulate their economies. It's also dampened hopes of further interest rate hikes in the United States, which has weakened demand for the US dollar and, in turn, strengthened the Australian dollar.
What happens now?
As is always the case, it's impossible to tell where the currency will go in the short-term. It's above US 76 cents now and could rise above US 80 cents, for all I know.
But the Reserve Bank of Australia does not want that to happen because a higher Australian dollar makes our economy less competitive against many foreign economies. Thus, if the Australian dollar does climb any higher, it's likely that the RBA would intervene to force it lower again.
According to The Australian Financial Review, Steven Saywell, global head of FX strategy at BNP Paribas in London, is one individual who believes the Australian dollar is "way over-valued". In fact, he believes it should trade at just US 68 cents, which is nearly 11% below today's price. He believes that a combination of lower inflation and a drop in commodity prices could get it there by forcing the RBA's hand into another rate cut.
As it stands, the market considers an August rate cut likely. According to the ASX's RBA Rate Indicator, there is a 60% chance of a cut next month, while most economists are also supportive of that view.
Predicting movements in currency values is inherently difficult to do, and there is nothing to say it will fall to US 68 cents. Then again, there's also nothing stopping it from falling below that level.
Given the dollar's rally over the last few months, however, investors may want to consider positioning their portfolios to benefit if that does occur. Investing directly in businesses listed on US stock exchanges is one option, while you can also buy shares in local companies with high levels of exposure to that country.
One option today could be CSL Limited (ASX: CSL) as well as Cochlear Limited (ASX: COH), while Westfield Corp Ltd (ASX: WFD) is also a reasonable option for long-term investors. As these companies repatriate their foreign earnings to Australia, the exchange rate helps boost their returns in terms of Australian dollars, while investors can buy their shares via the ASX without having to open international brokerage accounts.
