After gaining ground against the greenback in the final weeks of 2019 to end the year above 0.70c, the Australian dollar (AUD) fell sharply in January as the coronavirus outbreak dominated the attention of markets globally.
The AUD tumbled more than three US cents to a low of 0.6679 in late January as efforts to contain the virus disrupted China’s ports, left large parts of the country in lockdown and closed factories.
Concerns about the impact of the virus on the economy of our biggest trading partner overshadowed positive news on the domestic data front, with Australia’s unemployment rate and retail trade both beating expectations. Even the signing of a phase one trade pact between the US and China seemed to pass with hardly a glance from markets.
Coronavirus key to outlook
The mood of financial markets remains cautious to say the least with no signs of an imminent resolution of the coronavirus outbreak.
For Australia, the crisis will likely have an impact on tourism from China at a time when the industry is already being hurt by bushfires, while disruptions to ports and any slowdown in production and consumption will impact imports of our goods and raw materials to China.
The AUD-USD cross is also being weighed down by a strong US dollar, as worries about the coronavirus drive the greenback higher in a flight to quality. The US currency is being further supported by strength in the US economy in contrast to the continued weakness in the Eurozone.
While the AUD has continued to drift slightly lower in February, there is some support around the 0.6650 level. Last year we saw an 11-year low of 0.6668 and while the currency has dipped below 0.6700 in four of the past seven months, the AUD has rebounded every time.
The direction from here will depend largely on the coronavirus and whether this is a temporary or prolonged problem. On the one hand markets are concerned that Chinese officials may have understated the extent of the outbreak.
However, official figures indicate the number of new cases is declining, suggesting the outbreak is under control. If that’s the case, it’s a good sign for the AUD. It’s worth noting that in the SARS (severe acute respiratory syndrome) outbreak in in 2003, stock markets bottomed out around the time that the number of new cases started falling.
Of course, if the coronavirus issue is resolved, there will be other catalysts likely to impact markets later in the year including trade negotiations between the EU and the UK and the presidential elections in the US. It is important for businesses to set a hedging strategy that can protect them throughout market fluctuations.
Key takeaways for importers and exporters
Businesses that are importing goods or production inputs from China can consider some flexibility around their hedging in case of trade disrupts. Disruptions linked to the coronavirus outbreak have left some of our clients unsure as to when their shipments are due to arrive.
For importers generally, it is important to remain systematic about hedging and keep protection in place. It can become tempting to stop hedging and wait for the rate to go higher but over the last two years, companies that have done so have routinely been punished as it has gone lower.
Some businesses may also need to review their budgeted exchange rates. With the AUD going above 0.7000 in both June and December, when a lot of companies do their budgeting, it has caused many businesses to be optimistic about where they are setting their budgeted rates, and these may now need adjustment.
For exporters, it’s important to remember not to get greedy. Keep doing what you are doing and putting protection in place because if the cloud around the coronavirus clears, the AUD could well round above 0.7000, especially if the Australian housing market continues to recover.
Consult the experts
The currency markets are full of risks and opportunities for trading SMEs. Managing these risks and trying to predict market movements can be complex and a distraction from day-to-day business activity.
It’s best to consult with a foreign exchange provider throughout the year who understands your industry and can provide relevant currency market insights and analysis, as well as gauge what market shocks may be around the corner.
James Swerling is Senior Dealer, Fund & Institutional Sales at AFEX, a leading global payment and risk management solutions provider that specialises in cross-border transactions. www.afex.com