As some of you may have experienced, the foreign exchange market can bring joy or great frustration. Large swings can be sudden, rapid and unpredictable. Lately the British pound has had a good run against the antipodean currencies and in this brief wrap up, I will aim to explain the dominant factors that are currently affecting these exchange rates.

We will start with a two graphs to give you a clear overview of the market action in the past six months.

First, the Pound to Aussie

Secondly, the Pound to Kiwi

These charts are called “candle charts” with each candle representing a period in time. A blue candle represents a situation when the rate has moved higher, contra a red candle representing a move lower. These charts give you a clear indication that the Kiwi has been grinding lower all through this year, and the volatility in recent weeks only serves as an extension of the already established trend. The Aussie on the other hand had been relatively stable up until about a month ago when there was a sudden spike, with a subsequent correction.

So what is causing the rates to fluctuate in this seemingly unpredictable fashion?

Now, in order to really understand what affects the relative values in exchange rates, we must understand the way rates are set. In foreign exchange the benchmark currency is the US dollar and all other currency pairs are called cross rates. A straight forward example of a cross rate is GPB/AUD, but the same rate can be obtained going through the US dollar with a simple mathematical calculation. Consequently the GBP/USD rate multiplied by the USD/AUD exchange rate equals GBP/AUD, this since the US dollars simply cancel each other out using algebra. As an example, if we have got a GBP/AUD rate of 2.40 then this rate can be obtained multiplying a GBP/USD rate of 1.7777 with the USD/AUD rate of 1.35.

The reason for bringing this up is that the recent developments in our cross rates have had their origin in the relation to the US dollar. What I’m implying is that if the British pound manages to gain ground against the US dollar and the Aussie at the same time tumbles against the US dollar, then this implies a higher cross rate for GBP/AUD.

The general reason for the antipodean currencies continuously grinding lower ever since the start of 2005, I would assign to the eroding interest rate gap against other major currencies and the associated unwinding of the carry trade (explained below). Since interest rates have been relatively high “down under”, a lot of money has been invested here to take advantage of these higher yields. But with rates on the rise in other places of the world there is now greater competition for these investment flows, resulting in less investments and even liquidation “down under”. The way the so called carry trade works is that you borrow in one currency at a relatively low interest rate and then invest the borrowed funds in a higher yielding currency. The spread or difference in the interest rates will serve as the base for your profits on that trade, although the profits will be exposed to adverse movements in exchange rates.

Lately the market has been extremely focused on rising interest rates in America in addition to Europe and with an increasing herd of yield seeking investors taking positions in these currencies this has in effect led to a comparable “unwinding” of previous positions “down under”. The resulting selling of Aussie and Kiwi dollars in favour of Euro and US dollar has led to lower relative values in their exchange rates.

The British pound on the other hand has had a relatively low and stable interest rate for quite some time and hasn’t been involved in the same carry trade business. For this reason, the most recent sell off in the antipodean currencies didn’t lead to an equivalent sell off in the pound. This detail is one of the main reason for the most recent spike in the cross rates of GBP/AUD and GBP/NZD.

As always in the markets, when momentum has established itself in one direction or the other, this feeds upon itself and the trend gathers even more pace. At a distant point in the future an inflexion points will be met, the trend will then turn around and the whole thing starts all over again.

For the GBP/AUD rate the most recent move can be traced back to Friday the 16th of March. On this day the Aussie suddenly started to plummet against the US dollar. At the same time the British pound actually managed to gain a bit of ground, this as you might expect led to an increased cross rate of GBP/AUD. It is practically impossible to pin this sell off to one or a few isolated variables or events, there were simply more sellers than buyers in the Aussie dollar on that day. The initial sell off pushed the Aussie below 74 cents against the US dollar and substantial support wasn’t found until the rate was flirting dangerously with the 70 cent mark, this is the basis of the most recent rally for the pound.

The pound to Aussie had been stuck in a range between 2.33 and 2.37 for about two months and this break through proved to be very powerful. The momentum kept on gathering pace for almost two weeks hitting a high of 2.48. On the 27th of March the pound got hit by disappointing trade balance figures and GDP growth came in slightly below expectations, at the same time the Aussie hit an interim low against the US dollar. This date turned out to serve as the inflexion point when rates started moving in the other direction. Since then the Aussie dollar has again been gaining favour in the general market against most major currencies, with 25 year highs for gold and all time highs from metals like copper serving as support for this resource currency. The excitement about further interest rate increases in America has now cooled down a bit with another quarter point increase already expected in May and a 50 percent chance for a final increase in June.

For the GBP/NZD rate the trend has been much more predictable in the past five months. The exchange rate has been skyrocketing from a low of 2.49 in December 2005 to a high of 2.90 on the twenty seventh of March, with the Pound turning lower due to the information releases of that day. In the same time frame the Kiwi has suffered excruciating losses against the US dollar, plummeting 12 cents from 72 down to 60 cents. In general the Kiwi dollar has been plummeting against all other major currencies and once again interest rates play a major part. With an interest rate of 8.25 % the Kiwi dollar has been offering the highest rate amongst industrialised countries for quite some time. Foreign investors have had heavy bets on the currency to take advantage of this. Kiwi government bonds have even been issued domestically in Japan in order to induce foreign investors to take part. However, as previously mentioned, this yield gap has been continuously eroded and New Zealand’s attractiveness as a place to invest has been weakened substantially. In addition the part played by interest rates, the general economy in New Zealand has been under great scrutiny as of late with increased signs of weakness in sectors such has housing and retail trade. This general uncertainty is currently putting heavy pressure on the Kiwi dollar from many different directions and the future value is all but certain.

Summary and final words

Trying to pinpoint the effect of all different variables inevitably proves to be very difficult. When doing a transaction in the foreign exchange market, your individual situation is the most important variable to consider. If you are in the process of moving overseas then the sale of your UK property and assets and the purchase of assets in your new country usually define the window of opportunity available to you. Without the benefit of a crystal ball that we all would love to have, the only real control you have got over the actual outcome is to find a provider that is competitive and able to bring you as close to the wholesale rate as possible. You should also endeavour to understand the ways you can manage the risk you are exposed to through foreign exchange movements using tools such as forward contracts.

Please contact us if you would like to discuss your foreign exchange transfer and how you can minimise risks associated with market movements.