A combination of factors–including investors seeking the comfort of the US dollar safety, forecasts for weak global economic growth, softening commodity prices, speculation about the timing and pace of an anticipated rise in US interest rates and Reserve Bank of Australia (RBA) attempts to talk it down–sent the Australian dollar sliding in September and into October.

Sometime this month the US Federal Reserve will wind up its bond-buying program, marking the end of “quantitative easing” and another step toward normalization of monetary policy for the world’s most important central bank.

Attention has shifted to the timing of the Fed’s first interest-rate hike since mid-2006, with most pundits pointing the mid-2015.

Minutes from the Fed’s most recent policy meeting, released on Oct. 9, suggest members of the Federal Open Market Committee (FOMC) are concerned that recent gains in the greenback could slow exports and growth in the US.

The US dollar’s recent rally, by making imported goods cheaper, could add deflationary pressure that would keep inflation below the central bank’s 2 percent objective. Members also noted global economic weakness as well as geopolitical tensions.

“Some participants,” according to the minutes, “expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the US external sector.

“Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk.”

Germany’s leading economic institutes have said Europe’s largest economy would grow by just 1.3 percent in 2014, much lower than the 1.9 percent growth previously expected.

All this adds up to a Fed that could stay put on rates longer than the market currently expects.

The Chicago Board Options Exchange Volatility Index–known as the VIX– jumped nearly 25 percent, to its highest point since early February.

The spike in the so-called “fear index” reflects much broader concerns about the global economy. There’s strong correlation between movements in volatility and movements in the aussie dollar.

The RBA left its benchmark interest rate unchanged for a 14th straight month on Oct. 7, noting that although a recent sharp fall in the Australian dollar would help the economy, the currency still remained overvalued.

“The most prudent course is likely to be a period of stability in interest rates,” Governor Glenn Stevens noted in his policy statement. The RBA’s cash rate was held at a record-low 2.5 percent.

His language softened since September, when he said the exchange rate remained “above most estimates of its fundamental value.”

The RBA did remove its description of the aussie as “overvalued.” But Mr. Stevens noted it remained “high by historical standards.”

The Australian Bureau of Statistics reported that September employment data showed some weakening in the labor market, though the government agency said the series had become unreliable and would be reviewed. 
Australia’s unemployment rate rose to 6.1 percent in September from 6 percent in both August and July. The ABS revised the unemployment rate for those two months from 6.1 percent and 6.4 percent, respectively, after making changes to its methodology around seasonal adjustments.

The Australian dollar has enjoyed additional support due to an elevated spread between the yield on Australian bonds and US bonds. Should US interest rates move off current, still historically low levels the resulting compression could draw more capital away from Australian financial assets and further weaken the local currency.

The RBA is in a tight spot when it comes to its overnight cash rate. Mr. Stevens has attempted to “jawbone” hot Melbourne and Sydney property markets in an attempt to cool them down.

Raising interest rates would increase borrowing costs for homebuyers. It would also put upward pressure on the Australia dollar and impeded other policy objectives such as stimulating Australia’s manufacturing and export sectors.

As it is, most forecasters expect the RBA to stand pat at 2.5 percent well into 2016.

Shocks such as a hard landing for China or a collapse of the domestic property market could drive the aussie sharply lower from here.

More likely outcomes include finding support around the 10-year average in the USD0.88 neighborhood, thanks to further monetary easing in Europe and Japan and a surge in liquefied natural gas (LNG) exports from Australia as new facilities come on stream.

Over the next four years Australia’s LNG exports should roughly quadruple as seven projects move into production.

A significant share of LNG revenues will be repatriated offshore, but Australia’s advance to the lead among global LNG exporters will materially improve the Land Down Under’s current account balance.

Winners and Losers

The biggest beneficiaries of a lower Australian dollar against the US dollar would be those Australian-listed companies with significant US operations, including CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY).

European-exposed stocks such as Ramsay Healthcare Ltd (ASX: RHC, OTC: RMSYF) will also benefit from a weaker vis-à-vis the euro. The private hospital operator’s overseas profits would be worth more when translated back to Australian dollars.

Generally speaking, exporters, including resource producers such as Rio Tinto Ltd (ASX: RIO, NYSE: RIO) and BHP Billiton Ltd (ASX: BHP, NYSE: BHP), will benefit from a weaker currency. But factors such as volume and price of exports affect resource stocks as well.

It should be noted that a strengthening US dollar generally signals diminishing demand for gold.

Data from Bloomberg show that Australia’s four major banks tapped the wholesale funding market to the tune of AUD125 billion during fiscal 2014. And the banks’ hedging contracts mean the recent slump in the value of the aussie has boosted their coffers by up to AUD10 billion.

Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) provides a great example of the two-sided story of the Australian dollar’s steep decline versus the US dollar.

When the aussie slumped more than 13 percent during the spring of 2013, ANZ saw a AUD7 billion (about USD6.3 billion) boost to its balance sheet.

Under cross-currency swaps linked to debt issued in foreign markets, counterparties return collateral as the currency falls, giving the bank “an immediate cash in-flow.” It actually reduces the amount of debt the bank needs to issue offshore.

At the same time, a weaker aussie could also reflect diminishing risk appetite, which would weigh on banks’ capital markets operations.

GrainCorp Ltd (ASX: GNC, OTC: GRCLF), a major exporter, is another company that should benefit from a weaker Australian dollar. It makes its grain more competitive in global markets, and it should help farmer profitability, driving future investment.

Engineering services firms WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY) and Cardno Ltd (ASX: CDD, OTC: COLDF), both with heavy exposure to international markets, including the US, should be insulated at an operational level from challenging market conditions in Australia.

Because they’ve got less exposure to the Australian market, they’re going to be better positioned than other companies in the sector.

Sydney Airport (ASX: SYD, OTC: SYDDF) could benefit from increased foreign travel. Australia is already a top destination for vacationers from Asian countries, and its appeal will only increase as it becomes more of a value.

Companies that sell a lot of imported stock, such as electronics and appliances retailer JB Hi-Fi Ltd (ASX: JBH), will also be adversely affected.

The situation here is rather murky, however. Prices go up, so people are inclined to buy less of their product. But that might simply be offset by the increase in margin electronics retailers can put on the goods, so they can grab an increased profit share.

Domestic retailers could benefit from a weaker Australian dollar: Australian consumers, faced with higher prices from overseas online retailers, would buy more from domestic retailers.

Offsetting that is that retailers’ overseas inventory would be more expensive. However, many retailers that import inventory hedge for currency for a year ahead, during which time any changes to exchange rates do not affect them.

As it stands, the Australian dollar at around USD0.88 represents a sort of sweet spot, satisfactory for both importers and exporters.

Below USD0.85, down toward USD0.75 is an area where exporters will see very strong benefits, while importers will begin to feel real pain.

Meanwhile, it’s too early for earnings revisions and/or analyst downgrades based on recent currency movements.

Aussie Longings

The commodity cycle has moved into new, post-boom phase. But it’s hardly clear that this long period of record-low interest rates relative to historical norms is over. It’s more probable than not that interest rates will eventually move up from here. But “when?” and “how high?” are questions only the most aggressive speculators and/or snake-oil salesman will answer with certainty.

The only honest answer to both questions is “I have no idea.” There are simply too many moving parts, too many variables, including the human factor.

The Australian dollar has enjoyed a long interval of strength during this low-interest rate period, as much because of strong underlying economic fundamentals–supported, of course, by its abundance of in-demand natural resources, complemented by one of the lowest debt-to-gross domestic product ratios in the developed world–as anything else.

But the aussie is under pressure, having shed 7.3 percent of its value versus the US dollar during the third quarter.

That decline followed a 1.8 percent gain for the Australian dollar versus the buck during the second quarter.

The aussie was only modestly lower versus the buck from July 1 through the end of August, down 1 percent.

An otherwise controlled descent spiraled since early September, the risk-on currency shedding 6.7 percent of its value versus the US dollar from Sept. 5 through Sept. 30.

And it hit a 12-month closing low of USD0.8675 on Oct. 3. That makes for a decline of 10.6 percent since Oct. 22, 2013.

As of this writing the aussie is down 21 percent from its all-time closing high of USD1.0993 on July 29, 2011.

The RBA would prefer it even weaker because it would make Australian exports more attractive to foreign buyers and thus provide some economic offset against a slowing mining and resources sector.

At the same time, managers of foreign currency reserves, primarily central banks, continue to accumulate Australian dollar-denominated assets, establishing a strong floor.

Concerns about global growth–and emerging markets in particular–are weighing on the aussie and other “risk on” currencies backed by commodity-centric economies.

But there remains significant long-term support for the aussie, as deep-pocketed managers of foreign-exchange reserves–typically central banks–around the world continue to accumulate it.

According to the most recent data from the International Monetary Fund’s Currency Composition of Official Foreign Exchange Reserves (COFER) report, reserve managers boosted their holdings of Australian dollars by 2.3 percent during the second quarter compared to the first quarter.

The COFER database covers 146 reserve managers and accounts for 52.6 percent of their holdings.

As we’ve detailed in past issues, central banks have been accumulating both the aussie and the Canadian dollar over the past few years as part of a longer-term trend of diversification away from the US dollar and the euro, though these two currencies still account for almost 85 percent of the USD11 trillion covered in the COFER report.

Interest in the aussie remains subject to market forces, and central banks will alter purchases based on their particular strategic needs.

But demand for the Australian dollar is likely to persist, as reserve managers continue to diversify their holdings.

Australia’s strong underlying economic fundamentals and relatively solid fiscal position support a sound, trustworthy currency.

It’s tough short-term times for the aussie and for US investors who are long dividend-paying Australian equities.