What a Weak US Dollar Means
GFT currency research director Kathy Lien explores the ramifications of the weak greenback
America is killing the value of its currency. The US dollar has been falling since the beginning of the year and much of the decline can be attributed to the central bank’s ultra easy monetary policy. The Federal Reserve has kept interest rates at a record low of 0.25% for the past two and a half years, giving foreign investors very little incentive to own dollars. The only thing that has prevented the dollar from losing more value over the past three months is the currency’s safe haven status and even that is being challenged by US fiscal policies. Unfortunately America’s policies do not affect America alone – the weakness of the greenback drove the Australian dollar to a record high of 1.10 against the US dollar. Less than one year ago, one Australian dollar was worth less than 0.90 US cents and now one Australian dollar can buy nearly 1.08 US dollars – an appreciation of 20% in just a matter of months. With the US Federal Reserve talking about increasing stimulus and driving US yields even lower, we do not expect the AUD/USD exchange rate to fall back below parity anytime soon, which means Australia will have to learn to live with a strong currency.
Aside from driving up the value of the Australian dollar, the biggest consequence of a weak US dollar is higher commodity prices. Many commodities are priced in dollars, which means that when the US dollar falls in value, commodity prices rise. For example, when the US dollar index fell to a two-year low in April, the price of oil came within a whisker of $114 a barrel. Higher commodity prices drive inflationary pressures, making life difficult for central banks around the world. A strong Australian dollar helps to mitigate some of the pressure but usually it is not enough to ease the central bank’s concern.
For Australians, the primary benefit of a weak US dollar is that it increases purchasing power, making US products less expensive in Australian dollar terms. This has fuelled a new trend of buying products from US companies online and having it shipped back to Australia. It can also make everyone feel richer, more confident and willing to spend. This, of course, can come at the expense of local retailers who not only have to compete with each other but also with online venues. Vacations to America have become more attractive because a hotel room has become 20% less expensive over the past few months – these days, vacation trends can be dictated by the relative weakness of other currencies
Aside from shopping and vacations, a weak US dollar can also have a significant affect on the profitability of local companies, and the effects can trickle down to the average Australian. Another way to look at how a weak US dollar can impact you is to consider how a strong Australian dollar, which is a consequence of a weaker US dollar, affects local companies.
Measuring the impact
Potential Earning Surprises for Importers
Companies in Australia with a large amount of account payables in foreign currencies will also see their effective costs in Aussie terms decrease, which could lead to earnings surprises. For example, if an Australian company owed a US company USD$1 million in account payables, at 90 cents, that USD$1 million would be worth an equivalent of AUD$1.11 million but at an AUD/USD exchange rate of 1.10, the account payable in Aussie dollars would fall to AUD$909,000. The cost savings would have a positive contribution to earnings. Meanwhile, a strong Aussie can also increase the amount of international investments by Australian companies because it reduces the cost of cross-border mergers and acquisitions in Australian dollar terms. In other words, at 90 cents, a US company worth USD$100 million would cost approximately AUD$111 million. At 1.10, the same company with the same USD valuation would only cost approximately AUD$90.9 million, a savings of more than 18%.
Potential Earnings Disappointment for Exporters
The number one disadvantage of a strong currency is that it increases the cost of Australian goods on the global market. Australia is a major exporter and whenever the currency becomes too strong, exporters start to complain. Their greatest fear is that Australia’s trade partners (namely China) will start to look for alternative import destinations, which could be a major problem. At that point, exporters will be faced with the tough of decision of risking a fall in demand or reducing prices. As a result, earnings as well as trade figures could start surprising to the downside. We have already began to see a deterioration in economic data.
Reduces Foreign Profitability of Australian Multinational Corporations
A strong currency also negatively affects Australian companies selling products abroad. For example, imagine that Fosters sells a bottle of beer in the US for 5 US dollars at an AUD/USD exchange rate of 0.90. For Australian based Fosters that would mean revenue of AUD$5.55 per bottle of Fosters. Now suppose that the Australian dollar strengthened by 18%, bringing the AUD/USD exchange rate up to 1.10. The 5 US dollars that they charge for each bottle of Fosters beer now equals revenue of only AUD$4.50 instead of $5.55. Compound this by millions of Fosters beer bottles sold abroad and you will understand how a strong Australian dollar can hurt the profitability of companies such as Fosters. While a strong Aussie dollar reduces the cost for Australian companies to buy foreign companies, it increases the cost of foreign companies buying Australian companies. A similar dynamic occurs in tourism where a strong currency encourages Australians to travel abroad while deterring foreigners from travelling to Australia.
Weaker Housing Market
The Australian housing market has also received a tremendous boost from foreign demand. It is no secret that investors from China have provided significant support to the local housing market and slower Chinese growth plus a strong currency has already taken a toll on property values. With the Chinese Yuan falling 20% in value against the Australian dollar over the past year and the Chinese economy slowing in general, we are not surprised to see the Australian housing market suffer.
Trading the Australian and US Dollars
With the US dollar so weak and the Australian dollar so strong, many people have an opinion on whether these moves can be sustained. This opinion can be translated into a trade either through spot forex or contract for differences. Trading of foreign exchange contracts, contracts for differences, derivatives and other investment products which are leveraged, can carry a high level of risk, and may not be suitable for all investors so it is important to understand the risks before placing a trade.