Year-to-date, commodity-influenced currencies such as the Australian, New Zealand and Canadian dollars along with the Malaysian ringgit, Brazilian real and Chilean peso have all posted material appreciations against the US dollar, which have partially reversed some of the sustained depreciation experienced by these currencies over the last four to five years. The question is whether this Lazarus-like recovery is temporary or more permanent.
To answer this question one needs to focus on the major drivers of these currencies over time. These are relative monetary policy stances, terms of trade effects via commodity prices and valuation impacts (real exchange rates). Over the last three years commodity prices have experienced a significant correction as increased supply has interacted with a slowdown in Chinese economic activity and the planned restructuring of the Chinese economy (see exhibit 1 below).
Exhibit 1: Commodity prices have experienced a significant correction over the past three years (prices of various groups of commodities indexed to 100 as of May 2011)
Source: BNP Paribas Investment Partners
This significant correction in commodity prices has triggered relatively more accommodative monetary policy stances in economies ranging from Australia to Chile as domestic policy makers responded to the consequences falling commodity prices would have on their economies. Economies such as Brazil have had the twin problems of excessive domestic demand and a serious misallocation of resources, which led to a form of stagflation. The Brazilian real was substantially overvalued and the aggressive monetary tightening by the Bank of Brazil, accompanied a significant depreciation of the ‘real’ until this year. As commodity prices have corrected over the last three years, the deterioration in the commodity currencies’ real exchange rates has led to a significant depreciation in their nominal exchange rates, which has helped correct the overvaluation of their real exchange rates.
From a longer-term perspective, the commodity currencies’ real exchange rates are now back to fair value in most cases and their terms of trade have adjusted to the fall in commodity prices. Whilst the rebound in oil prices from their low point in January is significant, the year-to-date rebound in oil is less dramatic. Similarly, the overall rebound in commodity prices is less dramatic year-to-date, and is therefore, less of a driver in the appreciation of commodity currencies than some commentators suggest.
We believe, the major driver in the recovery of commodity currencies on the foreign exchanges year-to-date is the market’s change of perception regarding the expected path of US monetary policy. This is particularly so, as most central banks related to commodity currencies are either on hold or continuing to ease monetary policy, such as the Reserve Bank of Australia’s cut in its policy rate on 02/05/16 or the growing likelihood that the Bank of Canada will cut rates in the next few months. Despite the US Federal Open Market Committee’s (FOMC) decision to increase rates last December financial market scepticism over both the pace and magnitude of further rate increases has intensified. The FOMC’s reference to concerns over the international economic backdrop and mixed US data has only re-enforced the market’s view.
With changing attitudes to the pace of US monetary tightening being the key driver of the appreciation in commodity currencies year-to-date, this increases the likelihood that the recovery in commodity currencies proves temporary. A catalyst for a more permanent recovery in commodity currencies would require a sustained bull market in commodity prices, which then underpins a recovery in their terms of trade and forces their central banks to pursue monetary tightening as their domestic economies recover. Our central case remains that the FOMC will increase rates at least twice this year and that commodity prices will stabilise around current levels. We do not expect commodity prices to go into a sustained bull market at present, and therefore, we expect most commodity currencies to give up some of the recent gains once the FOMC returns to its tightening path later this year. In short, the recent appreciation of commodity currencies is likely to prove transitory.