The Australian Dollar (AUD) has made significant gains on the United States Dollar (USD) so far this year. Savvy investors may be contemplating how this impacts ASX shares.
Zooming out even further, the AUD has rallied from its post-Covid low of US59.6¢ in April last year, to recently hit a three-year high of US70.5¢.
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Why is the AUD gaining value?
In simple terms, the AUD is stronger against the USD mainly because Australian interest rates are rising while US rates are expected to fall.
The RBA's rate hike, combined with anticipated Fed cuts, have widened the interest rate gap in Australia's favour, making the AUD more attractive to global investors.
This is reinforced by strong commodity prices, risk-on global sentiment, and broad US dollar weakness, all of which support demand for the AUD.
A new report from Canaccord Genuity and Wilsons Advisory said the RBA is expected to raise the cash rate again later this year.
The US Federal Reserve is still expected to cut rates multiple times.
What does this mean for ASX shares?
The report from Canaccord Genuity also highlighted what this divergence could mean for ASX shares.
According to Greg Burke, Equity Strategist, the rising AUD creates a mix of headwinds and tailwinds for Australian equities.
On one hand, a stronger local currency provides headwinds for the large number of ASX 200 companies that generate earnings overseas – currently ~40% of the index's profits – due to adverse currency translation effects.
On the other hand, somewhat counterintuitively, periods of AUD strength have historically coincided with S&P/ASX 200 Index (ASX: XJO) outperformance.
Metals & mining the clear winner
The report identified that the Materials sector has historically exhibited by far the strongest relationship with the AUD and the best performance during periods of AUD appreciation.
Mr Burke said this correlation does not imply causation.
Rather, this relationship reflects that both the AUD and commodity prices (and consequently, miners) tend to move together, as they benefit from the same underlying macro forces. These include robust global growth, improved terms of trade, broadly positive investor sentiment and a weaker USD.
When combined with tight supply dynamics and structural demand drivers for key commodities, these factors provide the necessary foundation for continued Materials sector outperformance.
How to target the sector
Some of Australia's largest companies by market capitalisation are metals and mining shares.
In fact, ASX materials shares make up roughly 24% of the ASX 200.
Some of the largest include:
Alternatively, investors can get broad exposure to this sector with ASX ETFs.
Options include:
