Currency risks to prepare for in the new financial year.
A new financial year is always a good time for SMEs to review their currency strategy, as currency fluctuations can have a major impact on a business’s bottom line.
In the 2018–19 financial year, the Australian dollar has experienced a steady decline against the US dollar, falling from highs of 0.7483 in July 2018 to a low of 0.6738 in May 2019, off the back of concerns about both domestic and global growth.
Looking forward, we see further potential headwinds ahead for the Australian dollar, which mean businesses should be approaching their currency strategy with caution.
Possible rate cuts
The Reserve Bank of Australia (RBA) surprised the market by electing to keep interest rates on hold in its meeting in early May, despite weak economic data, which showed Australia’s grew just one per cent year-on-year in the second half of 2018. They then did cut the rate to 1.25 per cent in early June and, as Australians continue to feel the slowdown in the housing market and stagnant wage growth, market commentators are predicting a further cut to a flat one per cent before Christmas. If this eventuates, it will further widen the interest rate differential between Australia and the US, which at the time of writing was 1.25 per cent. A likely knock-on effect would be a sell-off in the Australian dollar as investors and currency traders look to more “safe haven” economies for their sources of return.
Chinese economic growth
Another risk factor for the Australian dollar looking forward is the performance of China’s economy, which in recent months has been impacted by ongoing US–China trade talks. A third of Australia’s exports are shipped to China, which means the Australian dollar is often viewed as a proxy for Chinese economic activity.
“Another risk factor for the Australian dollar is the performance of China’s economy, which in recent months has been impacted by ongoing US–China trade talks.”
In May, the White House initiated a two-pronged assault on China: barring companies deemed a national security threat from selling to the US, and effectively banning Chinese telecommunications companies from doing business with the US.
Given these continuing trade tensions, a number of commentators are currently revising down their predictions for growth in China’s economy in 2019 and 2020. If this lower growth does eventuate, it is likely to weigh on the Australian dollar.
Falls in commodity prices
Strong commodity prices have continued to provide support for the Australian dollar. In May, iron ore broke through the $100-a-tonne level for the first time since May 2014 and Australia’s major oil companies are also benefiting from a US crackdown on buyers of Iranian oil.
It is important to note, however, that the price of resources can be volatile and vulnerable to global supply shocks, and any future downturn in resource prices would impact the Australian dollar.
Managing your currency risks
In AFEX’s view, despite the narrow range of the Australian dollar in recent months, this is not a time to be complacent given the downside risks that currently exist for the local currency.
For importers, many of whom are operating at costed rates of around 0.7000, having a currency hedging strategy in place can prepare for a move lower, with some flexibility to allow for future bounces in the Australian dollar.
Exporters and offshore earners, on the other hand, can continue to capitalise on the Australian dollar’s current levels, taking longer-term positions to maximise their returns.
Of course, currency markets are full of risks and opportunities for trading SMEs. We, therefore, recommend checking in with a foreign exchange provider throughout the year for relevant currency market analysis and insights for your particular industry.
James Swerling, senior dealer, fund and institutional sales, AFEX
This story first appeared in issue 25 of the Inside Small Business quarterly magazine.