The Australian dollar broke above 70 US cents last week for the first time since January, as investors took heart in our comparatively stronger economy.
Although a recession is unavoidable, the Australian dollar has made steady gains against the US ‘greenback’ since taking a plunge in March when strict containment measures were introduced.
That spells good news for online shoppers buying from overseas companies.
But AMP Capital senior economist Diana Mousina said it also comes with risks.
Higher Aussie dollar poses problems
Ms Mousina said the major downside to a higher dollar is that Australia’s exports become more expensive for foreign countries to buy, which could push down demand.
A higher dollar “is actually negative for growth” because it makes us less competitive.
But Ms Mousina said 70 cents is fortunately not high enough to jeopardise our exports.
“If it gets above 70 cents, it will be an issue for exporters, because it means that exports aren’t as cheap for international buyers,” she said.
In that event, the Reserve Bank would likely take action by expanding its quantitative easing program to suppress the value of the dollar.
Why the dollar has gained
The Aussie dollar broke the 70 US cents mark for several reasons, according to Ashley Glover, CMC Markets’ head of sales trading for APAC and Canada.
Firstly, the iconic greenback is losing its shine with investors.
In times of crisis, investors often rush to convert their cash to US dollars because it has a reputation as a ‘safe haven’ currency – its value remains relatively stable.
This is exactly what happened at the beginning of the pandemic: Investors holding Australian dollars were quick to swap them for greenbacks after China, our largest trade partner, shut down large parts of its economy.
But now that China and Australia are reopening their economies faster than expected, and performing much better than the US, Mr Glover said investors were increasingly happy to hold Australian currency.
The second driver of the Aussie dollar’s gains is that investors have shifted to a ‘risk on’ market.
This is when investors move their money from ‘safe haven’ assets (low-risk investments like cash and bonds) to riskier ones such as stocks.
Mr Glover said this ‘risk on’ attitude has been spurred on by the “significant global stimulus packages” rolled out by governments worldwide to support the economy.
The Australian dollar hit its recent low of 57 US cents on March 19 – the day the Reserve Bank announced it would engage in quantitative easing for the first time in history. (The US sharemarket took off at roughly the same time, too.)
Ms Mousina said the Australian dollar tends to rise in risk-on markets because Australia’s exchange rate is “pro-cyclical”.
This means it rallies when global economic growth is rising.
Ms Mousina said this is because the value of the dollar is linked to commodity prices, which often rise during periods of economic growth, as other countries require them to expand.
“When you have a risk on, positive momentum in markets, the Australian dollar does tend to rally,” she said.