It is a fact of life that most adults spend a large portion of their lives in constant pursuit of the dollar. Constantly striving to attain more in the hopes of living a better lifestyle and bulldozing most of life’s problems. Everybody wants it, but do they understand it? Where does its price come from compared to other currencies? What causes fluctuations in value? How does the value of my Dollar affect my other investments?
The simple answer is that traders move the price by buying and selling two currencies against each other. The deeper answer is that so much more can affect the movement of the Dollar and understanding how that works can allow an investor to utilize this knowledge to better understand their investments.
Over the last 12 months the Aussie Dollar has declined against the US Dollar by 8.24%. Now there have been several factors that have driven this, but perhaps the biggest driver has been the RBA cutting rates to record lows and continuing to have a dovish tone around future rates. The current cash rate sits at 0.75%, an all-time record low. This has driven the Aussie Dollar lower against most major currencies. The reason a currency tends to devalue when interest rates are lower is that the lower rates deter foreign investment and as such reduces the demand for the currency as there is no longer much bidding pressure to buy it as. Money generally tends to flow to currencies that pay the highest interest, that’s why generally countries with a weak or depreciating currency tend to raise rates to attract money back to their currency.
Now given that in the recent minutes the RBA considered the case for a further rate cut now, the chances that we will be going lower next year are very high. However, Governor Lowe did make comments that the RBA views 0.25% as the floor rate, anything lower than this will not give the desired effect that they want. Given that we are likely going lower in rates (analysts are pricing in a 100% chance of rates being cut twice next year by June), then it is reasonable to assume that the Aussie Dollar will continue to decline as well.
So, the question now is how will this affect equity investments?
Australia is a major exporting country which means that as investors we can use the currency valuation to our advantage. We need to look at this in terms of importing and exporting. As a currency declines in value, for example the Aussie Dollar against the US Dollar, then it becomes a more attractive environment for exporters. If the foreign currency is stronger than your own, then selling your product on foreign shores and converting the funds back to your currency will result in an advantage for the seller. On the flip side importers benefit from a stronger local currency because they can purchase more of the foreign currency and effectively get more bang for their buck.
Equity investors therefore use this knowledge of a lower currency to target exporting companies or businesses that make a large majority of their revenues overseas. Healthcare companies are a good example of this as they majority of them tend to generate revenues in US Dollar. Investigating a company’s revenues and which currency they use can give you an edge when choosing the best investment for yourself. Do be aware that there are several other factors that can affect a currency valuation and so you shouldn’t rely on one factor when making an investment decision.