The fall of the Australian Dollar

July 27, 2015
Editor(s): Edward Zhang
Writer(s): Naren Rajan

It was a dramatic day for the Australian Dollar on the 20th of July as it hit a six-year low against the US Dollar. The AUD was valued at 73.62 US cents compared to 74.07 US cents three days prior.  Two weeks prior to the dip, the AUD has been moving between a band aof 73.50 US cents and a little more than 74 US cents.

Among the main key drivers for the devaluation include lower commodity prices, recent market tremors and the escalating expectations of an increase in the US interest rates in September. Higher US interest rates are expected because of the good economic news that keeps coming out of the US. The decrease in unemployment and a spike in the housing index added with the stellar performance from notable companies such as Citigroup, eBay, and Netflix contribute to the prospering economy in the US. Higher interest rates in the US attract money flow into the country, hence foreign investors in Australia prefer investing in the US rather than keeping their money here in Australia. This, in return, creates a downward pressure on the currency which is helping lower the AUD.

ANZ senior foreign exchange strategist, Khoon Goh, speculated regarding the currency when he said, ‘with commodity prices remaining under downward pressure, we can expect leveraged funds to continue increasing their short positions against the commodity currencies.’ ANZ reported that the AUD is under intense pressure due to market tremors from the Greek debt talks resulting in massive quantitative easing measures taking place in Europe and Chinese equity sale.

A lower currency means that locally produced goods would be relatively cheaper compared to goods produced elsewhere in the world and this will encourage the growth of the export industries such as education, tourism and mining as well. Some of the part-makers who have been incapacitated by the motor closures can also be saved by the weaker currency. The lower AUD would also mean Australia’s overseas purchasing power is significantly reduced, hence causing a drop in imports. Australians will have to pay more for overseas travel, cars and so on.  Consequently, a depreciating currency need not be a bad sign for the economy as a whole as it simply reflects that the economy is adjusting itself.

However, a proper analysis of the effects of the depreciating currency would also include the interest rates set by the Reserve Bank of Australia. If the RBA decides to further cut the interest rates in the current situation, it will exert a more intense downward pressure on the AUD. Housing prices in Sydney and Melbourne, on the other hand, has been off the boil due to the lower migration rate. The easing of housing prices has been assisted by warnings on housing bubble and speculations that negative gearing might be curbed. Negative gearing is a practice whereby an investor borrows money to acquire an income-producing investment property expecting the gross income generated by the investment to be less than the cost of repayments. The negative gearing speculation was sparked once again when Reserve Bank governor, Glenn Stevens gave statements advocating curbs to negative gearing. Although, it is unlikely that the Abbott government will act on negative gearing as elections are coming soon but the speculation still blunts the housing market effectively. With the dampening of the housing prices, the effect of the interest rate cut would therefore cause less volatile changes than it has in the past and would also have most effect on the AUD.

Some hold the opinion the that deteriorating health of the Canadian economy could provide some valuable insights on what the Australian economy will look like soon after the plunging AUD as both countries are weighed down by similar downward pressure on their respective.. Atul Lele, chief investment officer at private bank Deltec, agrees that global economic growth is booming but not for commodity-focused economies like Australia. The Bank of Canada cut interest rates to 0.5 per cent on July in a second cut in 2015, driven by the drop in oil prices and a challenging transition to non-energy-led growth. However, the central bank denied it was facing an economic recession. Mr.Lele claims that Canada is a fantastic six-month preview of what Australia faces in the future. He also clearly expressed his view that Australia needs to adopt monetary and fiscal easing as not enough has been done on the fiscal side. ‘Australia in some sense is like an emerging market. It’s exposed to some of the same dynamics of commodities and fiscal policymakers have not undertaken enough structural reform … it almost has the same problem that emerging markets are facing now. Today’s policymakers were hindered by the absence of action during the boom years’, he says.

On a similar note, it is also worth noting that the Australian dollar has a historic relationship with gold prices. However, the relationship was broken off at the beginning of October 2014.  The strong relationship prior to 2014 “was not one that anyone could rationalise very well,” said Mr Ray Attrill, co-head of foreign exchange strategy at National Australia Bank. It seems a little counter-intuitive because unlike iron ore, which forms a third of the nation’s exports, gold constitutes less than 10 per cent of it. Therefore, it would be perfectly rational to conclude that the price of coal is more significant than price of gold to Australia. The decrease in current gold prices could mean that the close relationship with the AUD is coming back but Mr.Atrill thinks otherwise and justifies through the fact that the AUD hasn’t suffered from the fall of gold price because the relationship has broken down.

Given the causes of the tumbling AUD, people like Mr.Atul Lele have explicitly stated that the Australian economy is bound to face a recession as he likens the situation in Australia to that of Canada. This indicates the need for the government to strengthen fiscal policies for the economy’s well-being. However, speculating itself is a dangerous game that can crush markets but one can always look at it optimistically and suggest that the fall of the AUD is a merely the economy’s mechanism to correct itself.

References

Cauchi, S. (2015, July 21). Retrieved July 23, 2015, from Financial Review: http://www.afr.com/markets/commodities/gold-and-australian-dollar-no-longer-tied-together-20150721-gih1kf

GOTTLIEBSEN, R. (2015, Jul 17). Markets Spectator. Retrieved 07 23, 2015, from http://www.businessspectator.com.au/article/2015/7/17/financial-markets/finally-rba-can-drive-australian-dollar-down

Muligan, M. (2015, July 20). Financial Review. Retrieved July 23, 2015, from http://www.afr.com/markets/currencies/australian-dollar-touches-sixyear-low-20150720-gig4z9

Poljak, V. (2015, July 20). Financial Review. Retrieved July 23, 2015, from http://www.afr.com/markets/currencies/australian-dollar-tipped-to-drop-below-us60-in-canadianstyle-plunge-20150720-gifttg

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ, its Partners and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

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Edward Zhang
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