The Australian dollar surged to more than two-year high and some experts are predicting it will go a lot higher. That's bad news for many S&P/ASX 200 Index (Index:^AXJO) stocks.
The Aussie battler is currently trading at US74 cents, taking its gain since the depth of the COVID-19 in March to nearly 30%.
The advance isn't over as market economists are predicting our dollar to hit US80 cents next year, reported the Australian Financial Review.
What's driving the exchange rate
It's more the weakness of the greenback than the strength of the Aussie that is driving the latest rally. The change in the US Federal Reserve's inflation targeting policy is causing the US dollar to lose ground against its peers.
The Fed signalled it will tolerate a temporary jump in inflation above its comfort zone. This means it can release more stimulus into the market without worrying about inflationary pressure.
Unless the Reserve Bank of Australia (RBA) announces something unexpected when it releases its interest rate decision at 2.30pm today, the Aussie is likely to stay on the front foot.
A$ finding support from commodities
But the rise of the Aussie isn't only supported by a flagging US dollar. The stubbornly high iron ore price, which surged nearly 35% to over US$122 a tonne over the past year is also fuelling its ascend.
There's also a bit of a virtuous cycle happening here. The retreating US dollar tends to lift commodity prices, including copper and gold. Commodity exporting nations like Australia and Canada will see increase demand for their currencies as a result.
Further, the RBA is far more resistant to pumping liquidity into our financial system compared to others, including the Fed. This means less downward pressure on our currency than the US dollar.
Why a stronger Australian dollar is a headwind
However, a strong Aussie isn't what we need as Australia awaits official confirmation this week that our economy has slumped into a recession. A stronger local currency is an earnings headwind for large cap stocks on a net basis.
If the Aussie is on a new uptrend as currency forecasters are predicting, we could see earnings downgrades start to flow through ahead of the February reporting season.
ASX stocks with large US dollar exposure will see earnings drop when profits are converted into the Australian dollar.
ASX stocks facing earnings headwinds
Many of these companies have hedging contracts in place to reduce the volatility, but even then, the expected big more in the Aussie towards US80 cents will hurt.
Some of the ASX large caps with significant US exposure includes global logistics group Brambles Limited (ASX: BXB), building materials supplier James Hardie Industries plc (ASX: JHX) and gaming machine maker Aristocrat Leisure Limited (ASX: ALL).
Even the Afterpay Ltd (ASX: APT) share price will feel the heat given it's counting on its US expansion to became a key growth driver for the tech superstar.
Let's hope the Aussie bulls are wrong.
