Currency volatility is a sure bet

Global markets look set for a bumpy ride in 2020, and business leaders must prepare now.

In the coming year, the only certainty is uncertainty for the Australian dollar. It's the first time in recent memory that local interest rates are lower than US interest rates (they may go even lower with the RBA open to further cuts). And with the ongoing US/China trade war there are several material risks that could trigger a currency shock for the Aussie dollar.  

Moreover, global markets will operate markedly differently in 2020, adding to the general sense of instability. While currency fluctuations can be difficult to predict in any detail, the International Monetary Fund (IMF) World Trade Uncertainty Index (which remained largely stable over the past 20 years) recently spiked - from 5.11 in 2018 quarter 1 to 99.67 2019 quarter 3, up 1,852% - reflecting trade tensions between the US and China. 

The liberalisation of trade and investment flows has been key to Australia’s economic prosperity. However this prosperity is at risk if policy makers and business leaders do not carefully consider the role Australia can play in the ‘Game of Trade.’

The good news is that while currency volatility might be on the cards, there’s plenty business leaders can – and should – do to determine whether to hedge or bet when it comes to currency.

The Australian dollar is a global player

The Australian dollar punches well above its weight. The IMF places it as the fifth most traded currency, accounting for a daily average volume of just under half a billion US dollars.

While the Australian dollar is shaped by many factors, its value is ultimately determined by the players within global currency markets. As such, current uncertainty in the economies of our trading partners, coupled with fluctuations in commodity pricing, and an easing monetary policy, are linchpins in the intermediate-term exchange rate volatility we face.

Catching China’s cold

Nearly one third of Australian exports head to The People's Republic of China (PRC). Given our exposure to the PRC and the Chinese Yuan, as well as our reliance on resource exports, the strength of the Australian dollar is tightly bound to economic growth in the PRC. This connection exists to such an  extent that the Australian dollar is seen by many as a proxy for the health of the Chinese economy.

This means the Australian dollar is especially vulnerable to currency instabilities associated with the Chinese economy, in particular any escalation of the trade war with the US. 

The disruption caused by declining demand for Chinese exports will be compounded as corporates redirect global supply chains away from the PCR - as will the threat of a debt meltdown in the PCR. 

In short, the Aussie dollar will catch a cold if China sneezes in 2020.

What do currency fluctuations mean for you?

A falling Australian dollar will typically increase the cost of imports and dramatically increase a company’s cost of capital expenditure. It can also make overseas investments more expensive, and increase the cost of servicing foreign currency debts. Of course, Australian exporters will benefit from enhanced competitiveness created by a lower Aussie dollar.

On the other hand, when the Australian dollar rises exporters become less competitive. This pushes down dividends, which can decrease a business’ market value. At the same time, the cost of foreign inputs will normally decrease, giving importers a competitive advantage over domestic businesses.

Time to prepare your business

With currency uncertainty a sure bet in 2020, business leaders need to be prepared. The Aussie dollar is more likely to fall than rise so action is required to prepare for what the economy may have in store next year.

Business leaders should be asking five key questions:

• Is currency risk being appropriately managed?
• How much do we understand about our exposure to volatility?
• Can we capitalise on our enhanced competitiveness in a falling AUD market?
• Are we thinking strategically about offshore operations?
• What are the opportunities for integration into global supply chains?