Four dangerous currency exchange myths
Friday, March 20, 2015/
Being apathetic about currency exchanges rates can be very damaging for your business.
Let’s look at some of the dangerous myths that people cling to, to justify keeping their head in the sand.
1. What goes up must come down
Or the reverse: that a sinking currency must recover eventually. History tells us that movements in many markets tend to have cycles, but there’s no way of knowing when the tide may turn your way again. If you look at this graph of AUD/USD history (red line, with GBP/blue and EUR/green overlaid) there’s no obvious regular pattern of peaks and troughs.
What we can see is how vulnerable a currency can be to a “black swan” event, such as the GFC, where the Aussie dropped by a third against the Greenback in less than three months. That included a single overnight fall of 10% – potentially catastrophic for your business.
2. Market consensus is pretty reliable
Market consensus a year ago was for AUD/USD to be around 85c by year end. It actually finished 2014 nearer 80c. There were also several predictions for the Aussie to fall below 70c by mid-2014. Again they were wrong: it’s still well above that level now, as we approach Q2 2015.
Market factors shift quickly, and it’s very hard to predict long-term trends. The reality is that no one has a crystal ball.
In just over a decade and a half we’ve seen the Aussie sink to three for a pound, before doubling its equivalent worth two years ago before falling back to two dollars a pound. We’ve seen the Aussie plummet to less than half the value of the US dollar, before soaring past parity and then losing the majority of its gains again. We can’t predict where currencies will move with any certainty, but we can predict they’ll keep moving.
3. Domestic producers are immune
There’s hardly any business these days which isn’t exposed in some way to the global market. Even if you manufacture and sell locally, the chances are that some of your components are sourced overseas. Global oil price fluctuations influence transportation costs. Your competitors who do import/export may be affected and adjust their prices.
Critically, your customers may be affected if you’re not. Your organic tomatoes may cost the same to produce and sell with AUD/USD at 75c rather than parity. But your customer, having to shell out 25% more on electronics, clothing and other items, likely has a much more constrained grocery budget.
4. If oil goes up, the dollar goes down
The negative correlation between crude oil prices and the US dollar has been noted for a while. Recently the Greenback has surged as oil prices have plummeted. However, this relationship, according to research by the European Central Bank, is a relatively recent phenomenon. The ECB found that before the early 2000s there was “no such systematic correlation.”
It’s not safe to assume that a weak US dollar will mean high oil prices or vice versa. There have been significant periods of time when USD value and crude prices have risen or fallen in parallel.
The link between oil prices and the Australian dollar is even less pronounced as Australia is a major gold and oil producer, so the Aussie is often seen as a commodity currency.
In addition, the current USD/oil correlation may not persist in future. The drivers of oil prices are different to those driving the USD. More significantly, OPEC could at any time choose to break the historic link between crude oil and the US dollar and has discussed doing so in the past.
FX volatility is an issue for all businesses. We know currencies will move and the wisest approach is to be pro-active and take an appropriate hedging strategy for your underlying business.