Commodity-based currencies in top 5 as global prices soar – Global Banking & Finance Review
Through Ali Jaffari, Head of North American Capital Markets at Validus Risk Management
Global commodity prices continue to climb as the one-way streak persists in the wake of stronger-than-expected global growth and economic recovery. The IMF expects the global economy to grow 6% in 2021 (up from a previous forecast of 5.5%) – this highlights the fastest expansion since 1980. From Metals to Energy in passing through agricultural markets, the gains in commodity prices are reaching multi-year highs (if not historic highs as seen in iron ore, copper, palladium, etc.) without any deterrent effect on the current trend . So it’s no surprise if you look at the best performing G10 currencies against the US dollar this year – commodity-based currencies like CAD, NZD, and AUD are all in the top five.
There has been substantial growth in demand across the commodity complex as major central banks continue to apply accommodative policy measures and vaccination rates rise, improving global mobility. China’s outsized recovery alone has raised its consumption to pre-pandemic levels, supporting the recovery in energy and metals markets. Australia, in particular, has benefited from China’s rebound as its top exports to the country, including iron ore, coal and wool, boost its trade surplus.
Of all the major currency pairs, the CAD has been the best performer against the dollar, gaining + 5.5% in 2021 so far. A number of factors contribute to its strength – a strong wave of economic data that exceeds consensus estimates (recent inflation is + 3.4%), convergence with the United States on vaccine deployment and unwavering growth in commodity markets. The Bank of Canada publishes a commodity price index based on 26 commodities produced in Canada and sold around the world. Since the start of the year, the index has risen by around 30% to reach 7-year highs. While oil prices have always been a major driver of the Canadian dollar, other base metals and commodities have also been a major contributor to the loonie’s recent appreciation.
Unlike the Bank of Canada, which was one of the first major central banks to pull out of its pandemic-related quantitative easing initiatives, the Reserve Bank of Australia (RBA) and the Reserve Bank of New -Zeeland (RBNZ) continue to maintain their accommodative stance with the The RBA does not expect to hike rates until 2024. The conciliatory attitude of the two central banks is somewhat surprising, given the strong rebound in the economic recovery in Both countries – Unemployment rates continue to fall, with Australia set to return to pre-pandemic levels in 2021, New Zealand’s core inflation is in line with the RBNZ target and the export prices of raw materials continue to rise.
Both AUD and NZD are up + 1.3% and 0.8% against the dollar this year, with high commodity prices boosting antipodes currencies. The local commodity indices on AUD and NZD show a year-over-year increase respectively on a commodity base group of 34.7% and 32.5% respectively. The Australian index is largely driven by bulk commodities (iron ore, coal) while the New Zealand index is mainly driven by its largest export, dairy products (up 41.3% year-on-year). annual). Likewise, the broader Bloomberg Commodity Index, more than a quarter of which is made up of metals (the remainder being energy and agriculture) is up around 24% since the start of the pandemic. Despite this unprecedented rise, it is possible that the full scale of the price increases may not yet have been fully incorporated into the currency’s strength.
Of the three currencies, the AUD currently has the strongest correlation (based on a daily percentage change over a 40-day cycle) with the Bloomberg Commodity Index at 39%. The respective NZD and CAD correlations lag slightly at 30% and 36% respectively. Interestingly, these correlations were much higher and averaged around 60% earlier in the quarter and quite responsive to the commodity headlines. It is not uncommon to see correlations with commodity-based currencies lagging behind sometimes, especially when other market factors are in play. Look at the CAD and crude oil prices – this is often the case. that we see the breaking of the relationship between the two. In fact, we have seen a steady decline in recent weeks and the CAD does not appear to be phased by the recent drop in crude oil prices as other staple prices remain dynamic namely agriculture, forestry, metals, etc.
As the global recovery progresses, as central banks maintain expansionary policy measures and a continued rise in commodity prices, commodity-based currencies appear well positioned to thrive. As other market factors subside and correlations with basic commodity prices return to their average level, the rise in export prices will positively weigh on the trade balance, which in turn could directly influence the strength of the currency.
However, with increased global mobility, it is also important to take into account the price elasticity of certain products – take iron ore for example, China is currently dependent on Australian production, but is considering measures to moderate the market. through diversification (60% of iron ore imports come from Australia) or invest in / explore alternatives for its steel production. Finally, as a stronger currency may weigh on local exporters, the expectations of central banks will play a key role in assessing the impact of commodity growth on the national currency.