Shifting Gears: The Australian Dollar’s Roller Coaster Ride

  • Timing markets and especially currency markets can be challenging
  • We review the impact of currency to investor returns for 2020
  • And explain why hedged and unhedged exposures differently impacted investors’ portfolios for the first half of 2020 

The first half of 2020 proved to be a roller coaster ride for investors. Equity markets sold off through the first quarter as market risks spiked with the spread of COVID 19 but rebounded in the second quarter as central banks came in to support the global economy.

That roller coaster ride was also seen in the Australian Dollar (AUD). After hitting a record low in March 2020 against the United States Dollar (USD), the AUD has since rallied, reaching a 12 month high and exceeding levels prior to the COVID-19 selloff.

Source: Bloomberg Finance L.P., 31 August 2020

The rebound of the AUD has been driven by a number of factors:        

  • Risk rally. With the AUD being a high beta currency, seeing it selloff in high risk environments and rally as the perceived risk environment improves is not unusual.
  • Falling USD has seen relative strengthening in the AUD. Over the last few years, interest rates in the US have been higher than in Australia. However, the effective Federal Funds Rate in the US was slashed close to zero while the Reserve Bank of Australia provided some optimism by dismissing the possibility of negative interest rates.        
  • Increased optimism around COVID-19 and the economic data. An economic rebound in China, Australia’s biggest export market, and positive developments on a  coronavirus vaccine have also helped the AUD rally against USD. We have also seen better containment of the virus domestically, despite the recent surge in infections in Victoria.

Going forward we expect to see further choppy waters for the AUD, this outlook is impacted by a number of factors. Longer term, valuations metrics will drive the AUD but with the difference between interest rates between Australia and the US now at zero, short term factors may find more prominence. 

Source: Bloomberg Finance L.P., 31 August 2020

Market risk will be a significant driver of shorter term currency moves, and with the AUD being a high beta currency it will be more exposed to short term risk factors. For Australian’s investing in international markets, currency is likely to have a significant impact on the returns they generate.

Year to date we can see the impact.

Source: Bloomberg Finance L.P., 31 August 2020

Hedged investors faced larger drawdowns through the market selloff. Unhedged investors who maintained some foreign currency exposure experienced reduced drawdowns through the selloff as the foreign currency provided some diversification benefits. Conversely the unhedged investors lagged in the market rally as the AUD benefited from the improving risk sentiment.

While timing markets is notoriously difficult, it’s important to understand the impact that currency can have. Longer term strategic views should form the baseline for determining what currency exposure to hold but adjusting that exposure based on understanding the risk related characteristics of currencies can help investors navigate through shorter periods of market risk. 

Whatever your view around the correct hedge ratio to target, the ability to blend hedged and unhedged ETFs makes implementing those views easy to achieve.