Why the US dollar is important to Australian investors
As Australians, we have a pervasive exposure to the US dollar in our daily lives. This comes about through a variety of mechanisms, chiefly because many of the things we need are either priced in US dollars or have a US dollar component. Examples range from the obvious like raw materials and energy (think oil price reports in the news), to the less transparent like technology and software (look at where the price for an iPhone or Microsoft software is set).
Particularly important for Australians investing for their retirement – we believe – is that as we age, our exposure to the US dollar increases as we draw on increased medical support. Drugs and medical technology tend to have a global pricing component, inevitably in US dollars.
As well as an important portfolio diversifier, we believe that by investing in US dollar denominated assets we are also to an extent covering the US dollar risk in our future expenditure and, in doing so, helping to maintain our purchasing power.
It’s important to consider what level of US dollar exposure is appropriate for your situation
A 50 per cent weighting to US dollar assets in a self managed super fund (SMSF) portfolio might on the surface seem large; however, that weighting should be measured in the context of the size of the particular fund with respect to your ‘outside super’ assets and also what you think your expenditure levels might be in the future. For example, if you have significant Australian dollar exposure outside of super, including your residential property and ongoing income stream (whether from employment or a defined benefit pension), the US dollar exposure in your super fund portfolios should be seen as a counterbalance to this.
Through the last two years, we on the Dixon Advisory Investment Committee have held, and continue to hold, a short-term view that below 75 cents we are marginally biased to a stronger Australian dollar; whereas, above 80 cents, we view the Aussie dollar as overvalued. In the longer run, we believe the Aussie dollar is likely to weaken below this range.
There are two key reasons driving our long-term bias to a weakening Australian dollar
Firstly, we believe Australian cash rates are likely to remain static, and secondly, that US rates are likely to rise. We have long held the view that the Reserve Bank of Australia is unlikely to lift cash rates any time soon.
It is also interesting to note the difference between Australian 10-year Commonwealth government bonds and 10-year US Treasuries. Australian 10-year bond rates have only been below the rate of US Treasuries twice in the last 20 years, prior to the current instance. Each time that proved to weigh significantly on the value of our currency.
While this relationship has proven useful historically, interest rate differentials have been less useful as a predictor of currency strength in recent times due to the distortive impact of quantitative easing (QE – an approach to stimulate the economy where a central bank purchases government or other market securities to lower interest rates and increase money supply).
QE, among other factors, has seen the value of the Australian dollar diverge from levels predicted by interest rate differentials because the increased liquidity caused by QE has found its way into various global risk assets including commodities and hence supported the AUD. We believe the wind down of the central bank’s balance sheets should allow the interest rate differential relationship to resume. Consequently, we expect a weaker Australian dollar, however, it’s the early stages of that balance sheet unwind, meaning the path is likely to be uncertain and volatile.
Looking further out, we also believe that Chinese efforts to promote their currency (RMB) as a trading currency are important to monitor. In the long term, this competitive element could bring pressure to bear on the value of the US dollar.
A well-diversified portfolio remains an important approach to investing for retirement and suggest speaking with your professional adviser to ascertain the best weighting of all assets including US dollar exposure.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward-looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.