By Michael McCarthy

If you’re a share investor, and you sense your only forex trading experience revolves around your international holidays, think again. Almost all local investors are exposed to movement in the Australian Dollar (AUD), and it’s an increasingly important influence on the direction of the share market.

Unfortunately, the impact of movement in currencies on the share market is not clear cut. There are a number of potential implications when the AUD moves. These divide into the direct and indirect effects. Naturally, changes in foreign exchange rates affect every company that deals with any other part of the globe – costs and revenues in another currency go up and down with the AUD. 

Direct currency impacts

This is true on both the credit and debit side of the ledger, and on the profit and loss statement as well as the balance sheet. Companies with income in foreign currencies are favourably exposed to a falling AUD. Companies can buy more AUD with their FX income when the AUD drops. Additionally, any assets they hold in foreign countries effectively go up in value when the AUD falls against that currency. And just as they benefit from falls, a rising AUD hurts their bottom line.

Mining companies selling commodities priced in USD, healthcare companies with operations and revenues in other countries, financial and online groups with Asian subsidiaries and global industrial materials groups may all benefit when the AUD slides.

On the flip side, those with significant costs or liabilities in other currencies are at risk as the dollar falls. They often supply Australian consumers or businesses with goods imported from overseas. 

Of course, many companies are exposed on assets and liabilities, revenue and costs. The picture is further complicated by the fact that many companies seek what are known as “structural currency hedges”. If a company has a significant asset in Euros, it may create a matching liability by borrowing in Euros. In this way, gains and losses on the asset value caused by forex swings are offset by opposing losses or gains on the liabilities. Similarly, the income produced by the asset is (approximately) currency hedged by the costs of servicing the loan.

Investors may prefer to lean on expert analysis to determine the overall currency exposures of any given company. However, share prices are driven by a variety of factors, and even the most carefully calculated forex sensitivities are only a guide as to how any given stock will respond to currency moves. It’s often enough from an investment point of view to know on which side of the balance a company falls.

Globalisation and Australian shares

However, the most important effects can be indirect – and relate to the way international investors respond to currency moves. The increasing mobility of capital and the speed with which global investors respond to market developments means global investors regularly drive market direction and performance. 

For global investors the currency can be just as important a contributor to overall returns as the choice of investment. The two key currency questions for international investors are:

1) Where is the currency in relation to its historical ranges?

US investors are more likely to buy Australian shares when AUD/USD is closer to 70 US cents than US $1.10. This is largely due to valuation effects – Australian companies are cheaper for US investors when AUD/USD is low. However, the currency level can take weeks or months to make significant moves, this is a more passive aspect of currency impacts.

2) Where is the currency headed? 

This is potentially a daily “swing factor” in the share market. When forex sentiment swings, so do stocks. Last week’s inflation reading is a good example. Heading into the CPI data, market consensus was interest rates on hold for now, potentially higher AUD. The much weaker than forecast inflation numbers immediately lead to expectations of a rate cut, which saw the outlook for AUD swing to negative. 

Pressure on the Australian Share Price Index futures and banks commenced almost immediately. It appeared global investors were already bearish about the outlook for shares, but potential AUD strength brought caution. As soon forex swang, the selling began.

That’s why we’re all forex traders these days.