17 Jun 2020

Understanding the world of foreign currencies

By Damon Frith How to save money on foreign exchange.

Whether it's for work, leisure or family we all find ourselves dealing with foreign currencies at some point. By understanding why currencies change in value you will be able to better determine when to buy or sell currencies, and that knowledge can save you thousands of dollars.

The strength or weakness of a country's currency tends to reflect the economic health of the nation. It’s like a barometer.

By understanding the barometer of our own country and another you want to visit, you can be better prepared to decide when is the best time to make a currency conversion before you travel, send money overseas to family or make an offshore investment.

    What moves the barometer's needle?

    Countries with high employment and wage growth likely have strong consumer populations. When populations spend it boosts company profits and increases government revenue from taxes. It all adds up to strong economic growth.

    Investors, both individuals and institutions, and even other governments notice that prosperity and look for options to invest. This activity pushes the target currency higher. Of course, the currency will weaken if unemployment is rising, government revenue falling, and investors are shifting funds to other countries.

    Australia also gets a boost as an investment destination by being one of only eight countries in the world with the highest AAA credit rating. The ratings are determined by global credit agencies like Moody's and Standard & Poor and gives an indication of the risk associated with buying a nation's sovereign debt, better known as government bonds. It's another strength behind the dollar.

    Safe haven currencies

    Even the United States of America does not have as high a rating but it has other advantages. The US dollar is both the currency of choice for international trade and a safe-haven currency. The latter means there is confidence the nation’s treasury will continue to honour government debt even in dire times. Other safe haven currencies include the Swiss Franc, Euro and Japanese Yen.

    Commodity currencies

    Australia is known as a commodity currency due to its dependence on the export of minerals, gas, agriculture and bulk commodities like iron ore, bauxite and coal. Other commodity currencies include New Zealand and Canada.

    It has a real impact of how our dollar moves up and down, and its why during the Chinese-demand fuelled commodities boom between 2003 to 2011 the Australian dollar rose strongly against the US dollar. For a time it was even worth more than the US dollar.

    The outlook for commodities this year is subdued and not helped by trade tension issues that were so prominent last year. Disruption to the Chinese economy and global supply chains caused by the COVID-19 will also likely keep commodity demand suppressed.

    The Australian dollar was weakening even before the virus entered the picture. Since its last peak of US80c in January 2018 the dollar has been weakening because of the outlook for commodities and the fragility of the global economy in an ultra-low interest rate environment. The latter is a positive for a safe-haven currency so the US dollar has strengthened against our own currency.

    Currently the dollar is trading around US60c, and there is no data to suggest it will rally upwards anytime soon. However, it will likely strengthen once global economic growth resumes in a post-COVID world.

    Currencies move not just on what's happening within an economy but how that economy fits into the global picture. So when considering how a currency may move its important to take an international perspective.

    High impacts on the Australian dollar

    • Commodity prices 
    • Economic Outlook     
    • Performance of US dollar

    Perception is everything

    How investors perceive a country is an important driver for its currency. Australian's likely think of our country as having an active and vibrant tourism industry, and it does.

    But international investors do not perceive it as a prime driver of the economy, so impacts of COVID-19 on tourism will not have a major impact on the dollar.

    On the other hand, the economy of Thailand is heavily dependent on tourism, and as the virus spreads its currency (Thailand baht) is weakening.

    You don't need to be an economist to look for the big drivers that may be impacting a currency, some simple research should be sufficient. 

    Armed with this knowledge, you can make more informed decisions about managing currencies. Determine when it's time to get professional advice for more significant decisions like an offshore investment, or when to purchase another currency in preparation for future travel plans. For further information, visit Citi's Insights hub for regular wealth and economic updates.

     

    Damon is the content editor for Citi.

     

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