Return of the aussie dollar
2024 outlook could be bullish for an Australian Dollar resurgence as the Fed cuts rates and commodities lift.
The cycle of the Australian dollar often swings with the boom and bust of commodities. In a post-GFC world, this relationship has become highly correlated with more proactive Central Bank targeting. As the US employed quantitative easing to support stimulus measures and their trade balance, the Australian Dollar soared. Our local currency gained from the combined tailwinds of negative US real yields and China’s enormous appetite for Australian iron ore. The post-GFC mining boom period saw the Aussie dollar hold above parity with the US for nearly a four-year period between 2010 and 2014. The step shift of coordinated monetary policy pivoting from ‘trade-based’ quantitative easing to ‘inflation-fighting’ quantitative tightening has been momentous for global currencies. Over the last 15 years, we have seen dramatic swings in the Aussie dollar trading well outside the normal range of its long-run average. These price dynamics are often led by a proactive Fed actively targeting a market outcome and a demand-driven commodity supercycle. As monetary policy is expected to normalise in 2024, the Australian dollar will likely favour an easing rate environment and appreciate towards historical averages.
The world moved as one on interest rates in ‘22 and ‘23, strengthening the US dollar and markets as the risk-off safe haven for capital. In 2024, it is likely Central Banks will diverge towards more regionally nuanced rate paths, positioning investors to restructure and redeploy capital. The divergence of monetary policy will shift the globe not only to a more localised inflation narrative but also widen the gap of capital security and investor preference. The comparative position between nations in the rate cycle is becoming increasingly important for their respective domestic economic outlook and local currency strength.
If the Fed maintains the ‘soft landing’ narrative, the US will likely lead the shift to an easing rate path. A rate environment that is more conducive to a steady-state growth economy. Powell and the Fed will be incentivised to cut rates if inflation targets are met principally because of interest obligations on debts; US exports will be more competitive, and increased investor activity will lift the economy towards steady-state growth. The policy balance remains with the Fed to set the tone of global money and liquidity; as such, a probable fall in interest rates and US treasury yields will have an immediate effect on the US dollar. Its trading partners that adopt a more tentative inflation view will be slower to move out of restrictive territory, and that will drive an appreciation in their local currency caused by changes in relative nominal yields.
Australia has seen a dramatic depreciation in the $AUD over the last two years due to risk-off sentiment in a world attempting to quantify the implications of more expensive money. The Aussie Dollar may find some relief in a slower RBA pivot as the delay will provide greater clarity on the containment of inflation and higher yields will attract a greater level of capital inflows strengthening the AUD in a period of subdued growth and normalising inflation. Our local dollar, the world's fifth most traded currency, accounting for 3.38% of global trade, is often viewed as a risk-on currency. As the policy gears signal a directional change, investor appetite for risk is expected to gain momentum under more supportive Central banks. A more favourable rate environment suggests a trending Australian dollar; the underlying factors that align for a stronger dollar are the outperformance of Asia, primarily driven from China and India, and Australia’s next mining boom propelled by global mandated net zero targets. A dovish policy environment and a restructuring global economy are encouraging long-run growth signals for the Aussie dollar from the second half of 2024.
The macro backdrop supports a strengthening Aussie dollar in Q3 of this year improving purchasing power, yet overall sector performance in an easing rate environment should remain as the primary consideration for investors. Preferred sectors to perform under a less restrictive rate policy would be capital-intensive industry, businesses that don’t carry a huge amount of liquidity or cash on hand, and companies reliant on cyclical-facing revenues that will benefit from increasing demand and trade. An investment bias toward sectors that generally hold these characteristics would target: infrastructure, healthcare, resources, and small caps. These sectors should outperform in a cycle of cheaper money; operations with exposure to an appreciating Australian dollar would be a secondary tailwind.
Companies that will see a windfall from a resurgent Aussie dollar are net importers and overseas borrowers as foreign goods and debts will become cheaper improving overall margins. Our commodity-based exporters will lose some competitiveness in the global market; however, the expected upcycle from the green transition will likely protect local resource producers. In the recent iron ore mining boom, local producers were able to trade at all-time highs posting record profits alongside an Australian dollar that sat above parity. The green wave of capital investment may trigger a similar dynamic for the Aussie dollar and our resource-based exporters, as a rapidly growing market is forced to compete for scarce future-facing commodities. The overseas reliance on Australian LNG, lithium, and copper supports strong spot prices and elevated demand even if the Australian dollar is trading above historical averages.
The necessary future investment into net zero looks to be promising for the Aussie dollar; however, the recent big tech and infrastructure rally raises questions over entry price valuations as major indices break all-time records. The underlying investment must hold merit on a valuation basis irrespective of currency exposure. The fundamentals are still the determining factor of investment selection; positions with AUD exposure may contribute further upside to overall tailwinds.
Identifying companies that are most price-sensitive to any Australian currency movement will best capture the long-run thematic of an improving Aussie Dollar. The BetaShare Strong Aus Dollar Fund ETF (ASX: AUDS) tracks an appreciating Australian dollar with highly correlated exposures; it is currently trading slightly above $6, close to all-time lows and more than a 50% discount to pre-Covid price levels. The monetary policy switch will dramatically change the tide for the AUDS ETF. Expect a momentum shift for this ETF signaling trending upside to Australian dollar positions. The three ASX sectors with underlying fundamentals that will respond positively in an easing rate environment and carry AUD exposure are retailers, resources, and healthcare. These sectors will each have different responses to an appreciating Australian Dollar dependent upon their core business function and operation. Ideally, investors targeting trending sectors that are positively correlated to this AUD dynamic will see the best forex response translated to overall bottom-line improvement.
Australian listed retailers have taken a real hit in the tighter credit cycle as the forecasted recession threatened their business operations. Yet the Australian consumer remained resilient; recession forecasts have been pushed back, but the sector is still trading at significant discounts. The potentially huge upside for ASX retailers is any risk of sticky inflation that could push up the headline is expected to be services based. A positive trend for the sector paired with an appreciating dollar significantly reduces costs for our local retailers and makes the sector an attractive entry point for investors in 2024. JB Hi-Fi Ltd (ASX: JBH) has rallied 21% since November, hitting an all-time high in January; demand for the market leader in consumer discretionary would suggest market sentiment is shifting towards retailers. The two founder-lead success stories from the stay-at-home lockdowns, Temple & Webster Group Ltd (ASX: TPW), and Kogan.com Ltd (ASX: KGN), have seen their share prices seesaw over the last three years. In a post-Covid world, they are proving there is still strong consumer demand in shopping and shipping bulky goods all from the comfort of one's home. A strengthening Australian dollar will support their logistics and improve already highly effective supply chains in a cycle of loosening credit. Temple and Webster has risen over 60% since November, and Kogan soared more than 20% in the past month; these two major players have proven their ability to adapt through the business cycle, still trading at significant discounts from pandemic levels. An environment of cheaper money and a stronger Aussie will support both demand and supply economics for these reviving e-commerce players. Adairs Ltd (ASX: ADH) is Australia’s largest supplier of home-focused consumer goods, surprisingly distributes a sizable dividend more comparable to big miners than other retailers; it is up 40% since November but still considerably off 2021 levels, currently trading at $1.70. Bapcor Ltd (ASX: BAP), automotive supplier, and Adore Beauty Group Ltd (ASX: ABY), are also retailers to consider as confidence levels return. Bapcor trading near multi-year lows and Adore down 82% since its listing in November 2020 will benefit from an Australian Dollar rally and a consumer less threatened by recession risk.
As discussed, our ASX resources may not directly benefit from an appreciating dollar; however, the long-run thematic of the green transition will create an increasing level of forced demand for critical minerals regardless of the exchange rate. The necessary demand shift for future-facing commodities suggests another mining boom on the back of a rallying Australian Dollar. The big miners Rio, BHP, and Fortescue that were so successful over the last decade may be too exposed to iron ore to realise the full benefits of this trend in the near term. They are being forced to pivot and diversify through costly acquisitions with mixed success. These increased capital costs will put downward pressure on dividends until the new mining operations contribute to company profits. In the current market, Woodside (ASX: WDS) is a standout to benefit from a rising AUD and the net zero targets as the world becomes increasingly reliant on Australian gas. The recent share price story from $16 to $39 per share in an 18-month period as Russian gas trade restrictions came into effect demonstrates a market with narrow supply chains and buyers with limited alternatives. Woodside is currently trading around $32, paying over a 10% dividend, carrying specialised knowledge and capabilities as it ventures into the restricted space of hydrogen. The potential Santos merger (ASX: STO) signifies its intention to become a global energy juggernaut; possible operations on the east and west of Australia at the right valuation will cement Woodside for investors considering the changing energy landscape. South32 (ASX: S32), spun out of BHP, has become a significant miner in its own right with a market cap over $14Bn; importantly, its key assets are composed of both short-run and future-facing commodities. South32, close to $3, is more than 60% off its all-time high and a mid-cap resource stock that will benefit significantly from jumps in copper, silver, and coal; it is a hedged mining position with considerable Australian Dollar upswing. The Australian lithium producers will also continue to be hugely important in the next generation of mining; despite the recent cool-off in spot prices, Mineral resources (ASX: MIN) and Pilbara Minerals Ltd (ASX: PLS) have strong operations and are currently offering attractive entry points for investors. Australian resources with exposure to transitioning economics will have the most sensitive relationship with a resurgent Australian dollar.
The healthcare sector in a post-Covid world is positioned for recovery, particularly as the cost of capital lessens. Some major ASX players in the healthcare sector have made considerable gains in anticipation of rate cuts, with CSL and Resmed up 30% since late November and Cochlear trading at all-time highs. All three of these global health players derive over 50% of their revenue from overseas; a stronger Aussie would negatively affect earnings. However, for now, the implications of lower rates in a post-Covid world appear to be driving their share price as potential forex headwinds are ignored by investors. Ramsay Health Care, another major player in the ASX health sector, is trading at a 43% discount from KKR’s failed takeover bid of $88 per share less than two years ago. Ramsay, now sitting slightly above $50, is looking to offload foreign businesses and focus on domestic operations; timing this with a stronger local dollar will significantly improve performance and profitability.
The return of the Australian Dollar to long-run historical averages demonstrates considerable upside potential from the current spot price. An RBA that is even marginally behind the decision-making of other major Central banks will have significant uplift to our dollar. Still, the overarching story for 2024 is an easing rate environment and the capacity of Central banks to successfully deliver a ‘soft landing’. The persistent inflation thematic will remain as the primary driver for assets; therefore, active management and sector bias will outperform as rate cuts take effect in an outlook of subdued growth. Forex exposure in a changing rate environment is a secondary consideration to sectors that best hedge against the inflation fight. Over the next 6-12 months, divergent Central bank policies will give investors improved opportunities on a relative basis of valuations and currency exchange. The opportunities of the green transition suggest an influx of capital into Australia and our next mining boom supporting a strong Aussie dollar in a decade of change. Both cyclical and underlying macroeconomic factors are signaling a resurgent Australian Dollar.