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Uncertainty in Foreign Exchange as Trading Partners assess the health of the Australian Economy

March 24, 2020
Editor(s): Justin Lai
Writer(s): Marian Gobeaux, Matthew William, Annie Zhu

As coronavirus worsens and governments are forced to induce lockdowns, financial markets all across the globe are suffering due to the lack of economic activity.

There has been a wide sell-off in stocks, bonds and commodities as investors, companies and financial institutions have raced to move into cash (J.P Morgan, 2020). However, during this time of crisis, the US dollar known as the “safe haven” currency has strengthened from an increase in demand.  This was shown when Asian markets’ stock indexes plummeted to multi-year lows as investors dumped assets and paid dearly to swap local currencies into U.S. dollars. Furthermore, economists perceive Australia and Indonesia to be amongst the most exposed to a “dollar credit crunch” because of their higher dependence on foreign capital flows. (Wall Street Journal, 2020)

As such, the major movements in foreign countries’ exchange rates are inevitable and have drastic implications on the Australian economy.

Specific Foreign Exchange Analysis

On March 19th, the Australian dollar hit a 17 -year low, trading with the US Dollar at $0.594 (Ionescu, 2020). This is largely due to the weakening of China’s economy (a key trading partner of Australia) and the weakening of other major Asian economies. However, a combination of oil price rebounds, RBA’s stimulus package and the US Federal Reserve opening dollar swap lines to nine additional foreign central banks will help rally the AUD from its historic low.

As for Asian currencies, there has been a significant slump in value. The Hong Kong dollar has been trading close to the lower limit with USD, as the economy and employment rates continue to fade (Warry, 2020). The Chinese Yuan has had shocking volatility, from breaking 7 yuan as major sectors were unable to “keep up” to it strengthening at 6.886 yuan against the US dollar as coronavirus cases began to recede (Fisher, 2020). Recently, further fluctuation brought it back up to the current 7.10 yuan. Likewise, the Korean Won since early March’s outbreak has had excessive movements causing Won to continually rise to the current 1,277.72 won for 1 US dollar, and only recently gaining control from further depreciation. Even for currencies like the Japanese Yen that is usually considered to be stable, it has been subject to major fluctuation. Currently, the Yen has bounced back to 110.97 per US dollar as investors have become more risk averse given the current global financial uncertainty.

Additionally, Europe, the region of the largest outbreak outside of China is also fixed at $1.08 when trading with US dollars. Prior to Euros being pegged, it was recently quite volatile while gradually sloping down to hit a low $1.06 US dollar. This was due to the European Central Bank announcing more financial support to aid the economy, while maintaining interest rates unchanged, hence leaving currency traders unsatisfied. All in all, it has been a testament to many major currencies in the G10 to remain afloat as central banks strive for strategies to stimulate the economy during the chaos of COVID-19.

Implications for the Australian Economy

As the main source of export and tax revenue, Australia will suffer greatly from the adverse pandemic effect on foreign exchange rates and the uncertainty of its key trading partners. There is expected to be a 30% slump in China’s total outbound travel in 2020, with the first quarter contraction the most severe (Doherty, 2020). Even more worrying is that China makes up 36% of Australia’s LNG export (“Australia’s LNG exports to be impact by the coronavirus”, 2020) and it is estimated that the value of the Australian iron ore export to China is usually $60bn a year (Doherty, 2020). As such, economists at UBS state that Australia’s economy will shrink by 0.1% this quarter due to the outbreak and estimated to wipe A$6bn from GDP, or 0.9% off annual growth. Moreover, there is a strong belief that the growth of the GDP would be negative. Interestingly, iron ore price remains relatively high being 62% Fe Fines spot price still hovering around the US$90 per tonne mark. (“Rio Tinto, FMG and BHP prove volatile as iron ore remains elevated”, 2020). However, in the last month (ASX: BHP) shares have fallen 35% and (ASX: RIO) has fallen 24%.

The RBA now has cut the interest rate to as low as 0.25 percent and estimated to remain as low (Ky, 2020). Moreover, RBA will introduce an unprecedented strategy, to increase the cash supply and encourage investment. The RBA will buy up the government bonds and other financial assets from banks and pensions funds, thus, increasing the system with liquidity. The federal government has also introduced a $17.6b economic stimulus package as well as the $66 billion to support the Australian economy, mainly for small and medium enterprises. 

With lower interest rates, unpredictability in the foreign exchange market and Australia’s trading partners, it all points to the AUD spiraling lower to an abyss that has not been seen since Y2K. In a normal economic climate, this is fine as a decrease in the exchange rate will increase demand for exports. As exports increase, aggregate demand strengthens lowering cyclical unemployment and strengthening the economy. But, this economic climate isn’t normal, there is no longer that guaranteed demand Australia used to have. Although expansionary measures have been put in place by the government, with the implementation of quantitative easing, we could have an Australian dollar that not only decreases in value over time, but is unable to restore the economy into a healthy state that it once always would.

References

 ‘Assessing the Fallout From the Coronavirus Pandemic’ J.P Morgan Research (Consulted on March 23rd 2020) https://www.jpmorgan.com/global/research/coronavirus-impact

‘Aussie Dollar at 55 Cents, Stocks Plunge in Korea: The World’s Desperate for Dollars’ Wall Street Journal (Consulted on March 23rd 2020) https://www.wsj.com/articles/aussie-dollar-at-55-cents-stocks-plunge-in-korea-the-worlds-desperate-for-dollars-11584619914?ns=prod/accounts-wsj

Australia’s LNG exports to be impact by the coronavirus. (2020). Retrieved from https://www.consultancy.com.au/news/1671/australias-lng-exports-to-be-impact-by-the-coronavirus.

Doherty, B. (2020). Australian iron ore, gas and lamb exports to be hit hard as coronavirus crisis continuesRetrieved from https://www.theguardian.com/world/2020/feb/12/australian-iron-ore-gas-and-lamb-exports-to-be-hit-hard-as-coronavirus-crisis-continues

Euro falls after ECB holds fire, dollar jumps as spreads widen. (2020). Retrieved from https://www.cnbc.com/2020/03/12/forex-markets-ecb-coronavirus-in-focus.html.

Fisher, K. (2020). Yuan Rebounds After Coronavirus Fears Push Currency to Seven-Week Low. Retrieved from https://finance.yahoo.com/news/yuan-rebounds-coronavirus-fears-push-084038764.html.

Ionescu, I. (2020). AUD/USD: Aussie Rises as Oil Prices Rebound. Retrieved from AUD/USD: Aussie Rises as Oil Prices Rebound.

Ky, Jenny. (2020). Coronavirus Australia: Reserve Bank cuts cash rate and introduces Quantitative Easing strategy. Retrieved from https://7news.com.au/the-daily-edition/coronavirus-australia-reserve-bank-cuts-cash-rate-and-introduces-quantitative-easing-strategy-c-752843

Warry, A. (2020). Coronavirus and climate change impact Asian currencies. Retrieved from https://www.cityam.com/coronavirus-and-climate-change-impact-asian-currencies/.

Why are the BHP, FMG and Rio Tinto share prices crashing? (2020). Retrieved from https://www.ig.com/au/news-and-trade-ideas/why-are-the-bhp–fmg-and-rio-tinto-share-prices-crashing–200312

Yen, Swiss franc soar as risk appetite plunges on oil, coronavirus. Retrieved from https://www.cnbc.com/2020/03/09/forex-markets-yen-oil-exposed-currencies-in-focus.html.

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, our Partners and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

Meet our authors:

Justin Lai
Editor
Marian Gobeaux
Writer

As an exchange student from Sciences Po, I want to interact with the vibrant business community during my time in Melbourne. I am passionate of Political Economy and Economic diplomacy issues and have a strong interest in developing my Financial Markets analysis skills. On my personal time I enjoy  playing some good Sevens Rugby, discussing belgian beers as well as enjoying classical music and live art performances.

Matthew William
Writer
Annie Zhu
Writer