With Trump at large…and Brexit on the ropes…the global market has been pulled and pushed. Some days, it rejoices. Other days, it weeps.
One of the most obvious places we see these kinds of ‘macro’ effects materialising is on the foreign exchange market. Here you’ll see the shockwaves of an economic event visibly shaking the markets in the form of exchange rates.
In New Zealand, we like to compare our dollar to the American benchmark…or the pound sterling in some cases.
When President Trump tweets something contentious…or domestic GDP numbers disappoint…you can watch and see our dollar losing or gaining value in relation to its American counterpart.
For most of us, this stuff matters when we go on holiday.
Quick trip to Tokyo?
Let’s see how the yen’s stacking up today. A bit weak? Great, looks like we’ll be able to opt for that sumo wrestler meet-and-greet after all.
But if you’re in a business that involves importing or exporting (as many Kiwi businesses do), then you’ll know that exchange rates can play the other way too.
Let’s say the yen is down. That means we’ll be able to import Japanese electronics a bit more cheaply than normal…but it also means that the Japanese importer looking to bring in New Zealand merino wool might limit his order or even cancel altogether.
It’s a complex game, but one that affects New Zealanders in every industry.
I’d like to quickly run through the basics of foreign exchange today…then we’ll follow up with a more strategic perspective from Simon, our own in-house forex expert (forexpert?), on how you can navigate the currency market to your advantage.
Stronger and weaker currency
When you hear about foreign exchange and currency, you’re bound to hear the phrases ‘strong’ and ‘weak’.
I’m not a big fan of those terms…because ‘strong’ doesn’t always mean good and ‘weak’ doesn’t always mean bad.
For example, with that weak Japanese yen, the Kiwi dollar would be strong…which you’d instinctively assume is good. But if you’re a wool exporter with key customers in Japan, then you might see sales drop.
And if you’re in a more competitive market…like beef…then you might watch as your customers hop ship to work with someone that has a more advantageous, weaker currency…like Argentina.
So hearing that the Kiwi dollar is ‘strong’ wouldn’t be good news in those cases…
The opposite — with ‘weak’ currency — can be both good and bad too.
Let’s say you’re a house builder. You have $100,000 set aside for the treated lumber you need for the frame. When you set the budget, $100,000 was going to cover the bill.
But, lo and behold, you’re a few months down the line, and the NZ dollar has ‘weakened’.
Now, your $100,000 can only buy 80% of the lumber you need from your supplier in China. That means upping the cost of the build…possibly running into unexpected debt…disappointing your client…all because the Kiwi dollar ‘weakened’.
What drives the shifting rates?
For the most part, the factors driving foreign exchange are the same ones driving stock markets.
Good news like improved unemployment or higher GDP tend to cheer folks up and drive up confidence.
That, in turn, leads more people to buy that currency…which drives up the price.
Conversely, good news overseas can drive up foreign currencies…which can cause ours to ‘weaken’ relatively.
If there were only two parties involved, forex would be a breeze. But, alas, there are some 180-odd currencies to dabble in. Each one with a unique place in the global market…
And to make it more complex, each currency pair (like NZD/USD or GBP/CNY) can sometimes strengthen or weaken independently.
Taking advantage of temporary price inefficiencies between different currencies is called ‘arbitrage’.
But for the most part, since there are so many buyers and sellers of currency…you won’t see arbitrage opportunities last for long. There are simply too many folks out there watching the exchange rates, ready to pull the trigger on an opportunity when it appears.
That’s one of the reasons I love the forex market.
It’s a raw, free-market led operation. And when governments try to intervene and manipulate exchange rates, the markets quickly find workarounds… as we’ve seen in countries like Argentina where a thriving black market for foreign exchange popped up in lieu of government-imposed ‘official’ exchange rate.
(The Blue Dollar market is a story in itself…I may cover it in an upcoming issue of Money Morning NZ.)
Even if you’re not into the investing side of things…or aren’t involved in importing or exporting…it’s likely you know someone who is. So it’s worth keeping up with which major currencies are strong and which are weak…because that could be why your wool-exporting mate could afford that new Ford Ranger…and why your builder neighbor has trouble sleeping at night.
Foreign exchange matters.
If you’re interested in understanding more about how forex works at an investing level, you’re in luck. Simon’s agreed to offer some of his insider tips, based on his decades of experience in the field. Look out for this in an upcoming issue of Money Morning New Zealand.
Editor, Money Morning New Zealand