After months of central banks dominating foreign-exchange markets, commodities may be starting to bear more influence over currencies.
(Bloomberg) — After months of central banks dominating foreign-exchange markets, commodities may be starting to bear more influence over currencies.
With a peak in interest rates looming on the horizon, strategists at Nomura International Plc, ING Groep NV and UBS Wealth Management contend that the correlation between commodity swings and currency moves is returning for the first time in over a year. Loomis Sayles & Co. is betting on it, picking the Australian and Canadian dollars as beneficiaries.
“Commodity and forex correlations have rekindled in recent months,” said Dominic Schnider, head of global foreign exchange and commodities at UBS Wealth. That linkage was “broken” throughout last year as “interest-rate differentials played a more important role,” he said.
Countries with high exports of natural resources relative to their economies are typically referred to as having commodity currencies. Yet in recent years, there’s been little read across with commodity prices, as investors instead made bets based on how much central banks were hiking or the global risk appetite.
The Canadian dollar and Norwegian krone serve as an example. The former has been among the best performers among Group-of-10 peers this year, even though oil and gas prices have fallen, and the latter has been one of the worst. While fossil fuels are top exports for both, Canada has hiked rates by 325 basis points in the past year and Norway by 250.
That dynamic has started to change in the past month. Oil prices rallied in June for the first time this year, thanks to Saudi Arabian production cuts, while supply outages in Norway drove natural gas prices to their biggest monthly increase in a year. Currency markets responded, pushing up the krone the most, followed by the Canadian and Australian dollars.
“Euro-krone has been tracking natural gas prices pretty much one for one over the last few weeks,” said Jordan Rochester, currency strategist at Nomura. “Commodities appear to be the sole driver.”
The krone’s weekly correlation with gas was near a perfect 1.0 score in June, up from around 0.25 in January. For the Canadian dollar with daily oil prices, it was around 0.45, up from about zero at the start of the year.
That doesn’t mean the only way is up for these currencies. With markets still focusing on recession risks, Bloomberg Intelligence sees little hope that this year’s slide in commodities prices will be arrested in the second half of 2023. A delay in Federal Reserve easing would likely spur a further bottoming out for cyclical resources.
Still, Loomis Sayles fund manager Lynda Schweitzer thinks sentiment has become too bearish on global commodities, and is betting that a recovery plus the renewed correlation will support the Australian dollar and the Canadian dollar once the interest-rate outlook clears. She’s holding long positions in both versus the euro.
“Long-term we like the commodity currencies,” she said in an interview. “Once we get a clearer picture we’ll see more of the correlation return, commodities are capacity constrained so the corresponding currencies should make really good investments.”
Of course, central bank moves haven’t lost their importance. Commodity prices will still have to jostle with hiking cycles and equity market sentiment for traders’ attention. Non-commodity currencies such as the euro, yen and pound are all seen gaining this year, with many analysts expecting their central banks to tighten policy.
“There’s currently a mixture of three things driving price action, which is the hardest part,” said Nomura’s Rochester. “Rates say one thing, equities and commodities another.”
Nomura contends that this dynamic is exemplified through the Canadian dollar — it should be weaker given sluggish oil prices, but equity markets continue to drive upside. “If oil was in charge, USD/CAD would be at 1.3750 already,” Rochester said. The currency pair is hovering around 1.32, after the Bank of Canada surprised investors by restarting a hiking campaign.
Interest-rate differentials may be the most obvious factor still distorting the traditional commodity currency relationship, but BMO Capital Markets thinks other factors are also at play.
“The Canadian dollar and Norwegian krone’s status as commodity currencies has diminished,” said Stephen Gallo, European head of currency strategy at BMO Capital Markets. He pointed to stronger relative growth in US oil production, efforts to diversify away from fossil fuels, and Norway’s sovereign fund buying equities with krone.
For Gallo, the aggressiveness of the Fed’s tightening cycle further warped an already weakened relationship between commodity currencies and the dollar. But investors can still find opportunity in playing these currencies against ones with poorer energy fundamentals, such as the euro, he said.
Emerging Market Carry Traders Set to Shrug Off Rate Cuts
That kind of trade is popular for emerging-market investors, though such currencies have been less sensitive to fluctuations in commodities prices this year. The correlation is positive but quite weak at around 0.3 to 0.4 for the likes of South Africa’s rand, Brazil’s real and Chile’s peso.
Yet as markets grow more confident about the final stages of the global tightening cycle, a weaker US dollar would be on the cards and ING strategists then see commodities having a clearer impact.
“When the dollar starts to decline across the board, that’s a moment when markets start to look for opportunities,” said Francesco Pesole, currency strategist at ING, who expects the dollar to enter a downward trend this quarter. “The performance of certain commodities will become increasingly important.”
–With assistance from Colleen Goko.
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