HomeContributorsFundamental AnalysisDovish Fed Spurs Commodity Prices and Currencies Higher

Dovish Fed Spurs Commodity Prices and Currencies Higher

Commodity currencies are looking at their most bullish since 2015 after the Federal Reserve struck a dovish tone on inflation at its latest monetary policy meeting yesterday, lifting the price of risk assets, including those of commodities. Commodity prices have already been on the up during the past month, boosted in part by growing demand from China – the world’s biggest consumer of commodities.

This uptrend has helped drive commodity-linked currencies such as the Canadian, Australian and New Zealand dollars to 2-year highs, although the three currencies began their current rally in May. While doubts about the Fed’s projected path of three rate hikes in 2017 and the reversal of the Trumpflation trade have been the main contributor in reducing the appeal of the greenback, the three currencies have had other factors pulling them up.

The Canadian dollar is up nearly 7% in the year-to-date against its US counterpart, as the Bank of Canada recently adopted a hawkish stance and swiftly proceeded with raising rates for the first time in seven years at its July meeting. Many analysts expect one more hike by the bank in 2017, with the Canadian economy set to become the fastest growing among the G7 this year according to the IMF’s latest forecasts. Add to that some signs in the oil market that the global supply glut is receding and the willingness by OPEC members to take further measures, dollar/loonie may have more downside to go before it bottoms out. Though in the short term, a correction is looking overdue given that the pair’s technical indicators are in overbought territory.

The Australian dollar has made even bigger gains, appreciating by almost 11% against the greenback so far this year. Unlike the Bank of Canada, the Reserve Bank of Australia is not yet ready to turn hawkish. However, this hasn’t stopped market speculation about how soon a rate hike will come and the RBA has fuelled such talk by its own upbeat views on the Australian economy. More recently, expectations of a near-term rate rise have diminished as both inflation and wage growth remain subdued. But the aussie remains a relatively high-yielding currency, which it benefits from at times of risk-on sentiment.

The risk-sensitive Australian and New Zealand dollars have come back in favour with investors as the dollar falters on Trump’s political troubles and a less hawkish Fed. Yesterday’s FOMC statement was the most dovish the Fed has sounded this year regarding inflation, even as the US economy picks up some traction. Stronger commodity prices are also helping increase the lure of the aussie and the kiwi, as well as for emerging market currencies such as the South African rand, Mexican peso and the Russian ruble.

Base metals have been one of the big gainers in the commodities market recently. Copper futures prices have risen to the highest since May 2015 and iron ore is trading near 2-month highs. Other metals such as zinc, lead and aluminium are also up sharply this year. However, despite evidence that demand from China is on the up, metal prices are at risk of a reversal as part of this demand has come from companies replenishing their declining inventories, and China’s economy is expected to slow in the second half of the year. Steel rebar futures have already come under pressure amid fears of an oversupply.

The aussie remains highly susceptible to any downside reversal in metal prices, particularly iron ore, which Australia is a major exporter of, as this would damage the country’s terms of trade. The kiwi on the other hand is less vulnerable to the prices of resources as New Zealand is mostly dependent on dairy exports. In addition, the New Zealand government is enjoying strong finances at the moment and plans to increase infrastructure spending over the next few years, guaranteeing strong growth over the coming period. The kiwi has gained around 8.5% against the US dollar in the year-to-date as New Zealand’s economy looks set to outperform other advanced economies.

Judging by the above, the aussie’s rally appears to be the most overdone given the shaky outlook for metal prices. The loonie’s gains are perhaps the most justified as the BoC is raising rates and crude oil prices seem to be turning a corner (though it’s too early to say if oil is out of the bear market), while the kiwi is being supported by a strong New Zealand economy.

Another potential threat for commodity-linked currencies is that the dollar may yet resume its rally. Apart from the small possibility of a tax stimulus being announced in the US anytime soon, strengthening growth may push up wages and inflation much earlier than anticipated. This would inevitably lead to the Fed taking a more hawkish stance once again and the prospect of higher US rates could adversely impact global risk sentiment.

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