The Australian Dollar has slipped to a 17 year low. But will industries that ordinarily benefit from a depreciating currency lose out as the world continues to battle coronavirus?
Historically, during periods of substantial market stress, the Australian dollar (AUD) has fallen. This was seen during the dot-com crash in the late 1990s and the global financial crisis in 2008.
At the end of February 2020, the AUD posted 11 year lows, and then slipped to a 17 year low in March 2020, largely due to the impact of the coronavirus on financial markets. Ordinarily, a depreciating local currency is good news for the overall Australian economy, but will industries that benefit from a low AUD lose out as the markets react to the coronavirus pandemic?
A low Australian dollar is bleak news for consumers and businesses needing to pay for international products and services, as they become more expensive to purchase. This is particularly the case for retailers, such as those which sell electronics, cars and clothing, and also for Australians travelling overseas as they have less spending capacity for their dollar.
On the other hand, Australia is an export-oriented economy, so a weaker AUD can give our economy a timely boost, since our products and services become more globally competitive. For example, our manufacturers benefit as they’re able to sell more of their goods domestically and overseas. We tend to see more foreign tourists visiting Australia as their currency can go further, profiting our tourism operators. Our education institutions become attractive for overseas students, which can then benefit other sectors such as property and leisure. Australian companies that earn revenues in a foreign currency and incur expenses in AUD also benefit.
However, as countries around the world implement stricter measures to slow the spread of the coronavirus, industries that normally gain from a depreciating currency and the broader economy risk losing out. The travel ban for tourists and international students is severely affecting the tourism and education sectors, and the impact of the virus in China, one of Australia’s major trading partners, has significantly interrupted supply chains for Australia’s exporters, importers and manufacturers.
For Australian investors, the recent fall in the AUD has increased the value of their existing international investments such as shares and bonds, when converted to the local currency. However for new investors, this has translated to lower buying power for investments abroad, and once invested, any rise in the AUD will diminish returns in local currency terms.
If you are investing outside of Australia, such as directly in international shares, you are exposed to currency risk from the fluctuation of foreign exchange rates. Swings in the Australian dollar can either erode or add value to international investments.
To avoid currency risk, currency hedging can be used by investors to limit the impact of exchange rate fluctuations on investments that are traded in another currency. This is done by changing the exposure of assets from one currency to another by locking in the future exchange rate.
There are several important factors to consider when using currency hedging:
Type of investment – if you are investing in a defensive asset class like government bonds, where capital stability and income are key objectives, it may be more important to reduce currency volatility.
Risk profile – if you have a more conservative risk profile (i.e lower tolerance for risk), you may want to adopt a higher ratio of hedged investments versus unhedged investments to minimise your currency exposure.
Investment horizon – if you are more sensitive to shorter term volatility, you may prefer to hold hedged investments. However, if you are looking for growth in your investments over the long term, then currency fluctuations are less of a worry and simply an expected part of the investment journey.
Cost of hedging – there is a cost to hedging an investment, but not just in fees. There is also the potential of lost returns by wrong predictions. For example, if you choose to hedge your investments and the AUD depreciates, then you will miss out on gains once the value of your investment is converted into local currency.
Speak to your financial adviser for assistance in deciding whether or not to hedge your currency exposure aligns with your investment goals and personal circumstances.
In the short term, Morgan Stanley Research expects the AUD to continue to be under pressure amid continued market volatility, tight financial conditions, and uncertainty over the global economic outlook.
In the medium term, however, the Australian dollar should appreciate as global conditions gradually improve. It is likely to be supported by a combination of monetary stimulus that is already in full swing with fiscal expansion, and a sequenced recovery beginning in Asia that brings stronger commodity prices.
For more on the impacts of a low Australian dollar, speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.