BEA309 - International Finance Individual Assessment Answer

Trend Analysis Of Australian Exchange Rate 

Against Japanese And American Currencies 

Foreign currency movements are influenced by a range of factors ever since the advent of flexible exchange rate mechanism. The variables cause the exchange rate to move continuously. It increases or decreases in terms of volatility with time and circumstances. Before introduction of flexible exchange rate mechanism, exchange rate operated under fixed mechanism pegged to gold or silver (Ilzetzki, Reinhart & Rogoff 2021). Over the period, the system has evolved and flexible exchange rate mechanism exists with market intervention of central government from time to time. The movement in the currency is influenced by range of factors like the interest rate prevailing in the economies, rate of inflation, gross domestic product, Balance of Payment situation etc. (Afolabi & Kolawole 2020) Generally a currency is represented in the form of another currency in the foreign market. There are generally two types of currencies i.e. hard currency and soft currency. Hard currency represents currency of powerful nations like USA and Europe while soft currencies are currencies of developing nations like India. 

Change in the above stated variables along with the nature of currency plays a crucial role in determining the direction and magnitude of the exchange rate. In the present case, the company is planning to expand the business operations to United States or Europe. The company shall export lithium to these countries and shall receive money from these countries. Thus, in their present case they have a fear that USD or Yen may weaken against AUD in future which may reduce the final receipts of the company. Accordingly, the company is keen to understand the rationale for the historic movement and the probable future movement of the currency on the basis of present global economic trend and expectations. 

The historic data for the past two years show that the currency AUD/JPY and AUD /USD has been very volatile. The value of AUD against JPY has decline from 2019 and reached bottom in March end 2020. Post same, the value of AUD has risen drastically till 01/2021 and then again started falling. For AUD/USD similar movement has been up till March 2020 and post that AUD has strengthened significantly against the USD over the period of time. The reason for the said actions has been discussed as under: The GDP of Australia was either falling or growing at a very small pace which caused the exchange rate of the country to fall in the early slot of the graph which is presented as under:

 Figure 1: The AUD/USD and the AUD/JYP 

Source: RBA Exchange rate historical data

Further, the GDP has reduced more drastically during pandemic but the fall was lower than Japan and US which caused the currency to recover. Now, the GDP of Australia is increasing which is causing the currency to achieve new highs. The rate of inflation has risen very strongly in US and Japan as compared to AUD post pandemic. The said rise in rate of interest caused AUD to decline as per International Fisher effect theorem and thus the AUD strengthened as compared to USD. The Balance of Payment position for Australian Economy has been better than Japan and USA which has released large relief packages and there has been huge gap in the Balance of Payment position as compared to Australia. The said gap resulted in currencies of Japan and US to depreciate against the AUD. Thus, these are the main reasons for the currency to recover so strongly after the pandemic and why the currency was falling before the pandemic both in terms of Yen and USD.

Due to its relationship to risk, the Australian Dollar (AUD) and Japanese Yen (JPY) make for an interesting pair. On a short- to medium-term basis, the pair frequently ranks among the most strongly connected pairs to price activity in US equities. On carry flows, the pair often rises in low-risk environments, but the opposite is true when the markets take a "risk-off" stance. In its AUD/USD forecast, economic data firm Trading Economics predicted that the currency pair would trade. In terms of its AUD/USD estimate, CIBC Capital Markets was likewise quite pessimistic. It anticipated a decline in the AUD/USD rate to 0.67 in December 2022 and 0.68 in September. The price could rise to 0.70 in September and 0.71 in December 2023 while the pair recovers to 0.68 in March and 0.69 in June 2023 (Lepcha 2022). 

More optimistic about the currency pair was ING Group. The AUD/USD pair was expected to trade around 0.69 and 0.71 in the third and fourth quarters of this year, according to the Dutch multinational lender (ING Group 2018). The price of the currency pair was 0.72 in the first quarter of 2023 and increased to 0.75 in the fourth quarter. In the first quarter of 2024, it’s anticipated that the AUD/USD will remain at 0.75 before dropping to 0.73 in the 2nd quarter. In its AUD/USD estimate for 2022 as of 18 July, Westpac Institutional Bank predicted that the pair might trade at 0.72 by September 2022 and 0.75 by December 2022 (Westpac 2022). By March 2023, where the pair is being traded at 0.78 by June 2023 and 0.79 by September 2023, it projected that the AUD/USD will reach 0.77. In December 2023, the pair may reach 0.80 and hold there until March 2024. The Royal Bank of Canada forecasted that the AUD/USD would fluctuate between 0.69 and 0.71 for the whole 2022 calendar year. No forecast for AUD/USD to be given beyond year 2024 .At the same time algorithm based forecasting like Wallet investor, can also produce a 5 year forecast for AUD /USD on the basis of historical data for currency pair involvement.

As a matter of disclaimer, the above forecast can be wrong. One cannot use them as a substitute for own research purposes. Due diligence is required to be conducted before doing any form of investment by relying this paper. It is also important one shall not go into trading money if they cannot afford to lose the same. 

References

Afolabi, B. & Kolawole, A 2020, 'Exchange Rate Volatility and balance of Payments Problem in Nigeria', Journal of Economics and Finance, vol. 11, no. 1, pp. 23-32. 

Ilzetzki, E, Reinhart , C & Rogoff, K 2021, Rethinking Exchange Rate Regimes, viewed 1 September 2022 , < https://www.nber.org/papers/w29347>. 

ING Group 2018, FX talkING: Survival of the fittest , viewed 1 September 2022, . 

Lepcha M 2022, Australian dollar forecast: Can AUD stabilise and emerge from volatility? viewed 1 September 2022, . 

Westpac 2022, Australia & New Zealand weekly, viewed 1 September 2022, . 

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