Australia boasts a massive international import and export market on the back of a growing global marketplace. Along with increased opportunities are substantial risks for future business earnings.
Understanding these risks is important. In fact, not understanding the causes of currency risk exposure and fluctuations can result in even greater risk exposure. William Shepherd, Treasury Manager at online money transfer service OFX, says there has never been a greater need for fast, secure and low-cost foreign exchange payments.
The foreign exchange rate market is a global decentralised market for the trading of currencies. This includes all aspects of buying, selling and exchanging currencies at current or future determined prices. Many factors can influence the market, including global events such as data releases by central banks and finance institutions, natural disasters and even terrorism. Meanwhile, unnecessary costs from foreign exchange providers can increase potential losses incurred by adverse movements in foreign exchange rates, he says.
“In terms of volume of trading, the foreign exchange market is by far the largest market in the world, with over $5 billion traded daily,” Shepherd says. “This marketplace is where people exchange currency and the price is set by supply and demand”.
“If you want to invest overseas, you often need to invest in the currency of the country in which you are investing. If interest rates in another country are on the way up, you normally find that the currency demand increases, and therefore its value increases. So a key determining factor will be what that country’s central bank decides in relation to direction and timing of interest rate policy.”
Myriad factors
A good starting point to understanding a market is to look at the inflation rate, which is a key determining factor for a currency’s value, Shepherd explains. “A high level of inflation requires intervention. To curb people from spending in the economy, interest rates are usually increased, therefore making it more attractive to save, and less attractive to spend,” he says.
Aside from inflation rates, almost everything else you can think of can affect the global foreign exchange market, he adds. However, it’s very difficult to predict the future. Of course, it’s impossible to determine whether events that might happen down the track will impact on the broader economy – or not.
“When starting out in the foreign exchange market, the key thing you need to arm yourself with is a broad fundamental understanding of economics and how macro-economic factors can affect the currency,” he says. “You also need a technical understanding of the main indicators. Whether you’re hedging currency or buying money for overseas travel, a myriad of factors can have an impact on rates.
“Changes in relation to trade partners, a country’s demographics, even immigration rates, political uncertainty and overseas elections can affect the economy.”
“The health of a country’s key export market – such as milk for New Zealand – can also affect the economy. So, when the price of milk falls, the New Zealand dollar typically falls too. For example, a milk-poisoning scare in New Zealand saw the Kiwi dollar plummet half a US cent due to the increased risk of a weakening New Zealand economy”, Shepherd says.
Risk considerations
Risk trends can have a key impact. If the majority of global investors are prepared to take on riskier investment prospects, higher volatility currencies such as the Australian and New Zealand dollars are more likely to prosper. Conversely, when investors become risk averse, safe haven currencies such as the US dollar and Japanese yen would be expected to be in favour. Even when the US banking system was collapsing in 2008, the instinct was for everyone to buy US dollars.
“There can be any number of things that can affect a currency, so even looking at risk trends and whether people want to take on risk or stay away from risk can have an impact.”
Investors also need to consider that uncompetitive exchange rates and high transaction fees offered by the banks can affect international payments, Shepherd adds.
This advertisement feature is presented by OzForex Limited trading as OFX (ABN 65 092 375 703) (AFSL 226 484) and contains content advertising OFX’s products and services. Please read our Product Disclosure Statement at ofx.com.