The funk over global growth that gripped markets last week sent exchange rates into wild gyrations. But even in the worst of the turbulence one trend was clear: the underperformance of currencies exposed to the slide in oil prices.
The dollar fell against most major currencies as investors – previously betting on its rapid appreciation – pushed back expectations for the first rise in US interest rates. Norway’s krone and Canada’s dollar, which ended the week flat after touching respective four and five year lows against the dollar, were the exceptions.
With Brent crude prices down more than a fifth since the start of the year, iron ore down about 40 per cent and some dairy prices a third lower, the currencies of other big commodity exporters have also suffered.
The Australian and New Zealand dollars – stubbornly strong for years, despite policy makers’ efforts to nudge them down – have finally started to reflect worsening terms of trade, down about 6.5 per cent and 8 per cent respectively against the US currency in three months.
Foreign exchange investors are now adjusting to the prospect of slower global growth, further disinflation and a slower pace of monetary tightening in the US. One constant, however, appears to be the dismal outlook for commodity prices.
This is partly due to slowing Chinese growth and the surge in US shale production. But it is also premised on a stronger dollar, which tends to depress global demand for dollar-denominated commodities.
Investors who lost money in October as the dollar’s rally ground to a halt may be reluctant to renew their bets immediately – but many still believe the US currency is set to appreciate over several years, as US growth outstrips that of Japan and the eurozone’s struggling economies.
“This still feels like a perfect storm for commodity currencies. I don’t think the latest bout of dollar underperformance will be sustained,” said Valentin Marinov, strategist at Citigroup.
Alan Ruskin, strategist at Deutsche Bank, wrote: “There is a feedback loop. Strong dollar, lower commodity prices, global disinflation, less Fed tightening, slightly less strong dollar. This will slow but not stop a stronger dollar.” He said this would mean “huge relative terms of trade shocks” for big commodity exporters and consumers.
However, the link between commodity prices and exchange rates is less clear-cut than in the past. The economies of Australia and New Zealand are sensitive to the prices of their key exports – but their currencies have other attractions, with investors drawn to sovereign bonds offering relatively high yields and a coveted triple A credit rating.
This helps to explain why both the aussie and the kiwi, which often track changes in risk appetite and global demand, outperformed last week, when yields on US Treasuries fell faster than other sovereign bond yields.
The aussie, in particular, has not fallen nearly as far as the deterioration in its terms of trade would justify, argue analysts at Nomura, who think the correlation will be restored when US interest rates finally start to rise.
The Canadian dollar, although exposed to oil prices, has already fallen sharply this year, boosting non-oil exports and inflation. Moreover, in both Canada and Norway policy makers are balancing lower oil prices against signs of strengthening domestic demand.
“Norges Bank is cautious on the outlook for the oil industry but the economy has the best fundamentals in Europe,” Mr Marinov argued.
The slump in commodities is also an important factor for emerging markets. The drop in energy prices has hastened the slide in the Russian rouble, already suffering the effects of western sanctions on a weakening economy. And it has been a welcome reprieve for oil importers with big current account deficits, such as Turkey – whose lira is often traded against the rouble as a play on oil prices.
Perhaps even more important than the effect on terms of trade, though, is the fact that lower commodity prices will reinforce the global trend of disinflation. This could be important for monetary policy in economies already struggling to ward off deflation – such as the eurozone and Japan – and in poorer countries where food and energy carry a big weight in consumer price inflation baskets.
The consultancy Capital Economics notes that the recent falls in commodity prices could knock a full percentage point from emerging markets inflation over the next few months, leading to looser monetary policy than would otherwise be the case.
Nonetheless, the full effects will take time to filter through. Analysts at ING and BNP Paribas are among those predicting a short term bounce in many commodity currencies, whether on the back of a rebound in oil prices, or simply because the sell-off has gone too far.
Paul Lambert, a fund manager at Insight Investments, thinks “people will continue to play the terms of trade”, but may be cautious in doing so against the dollar, given greater uncertainty over the path of US interest rates.
Elsa Lignos, strategist at RBC Capital Markets, says the real effects on countries such as Canada will become more apparent if commodity prices remain low over the next few months – as oil producers finalise budgets for investment next year. “The link between commodities and commodity currencies is longer term in nature,” she said.
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