By Ali Jaffari, Head of North American Capital Markets at Validus Risk Management – Global commodity prices continue to surge higher as the one-way streak persists off the back of a global growth story and a stronger than anticipated economic recovery.
The IMF expects the global economy to expand by 6% in 2021 (vs a prior forecast of 5.5%) – this highlights the fastest expansion since 1980. From metals to energy to agriculture markets, commodity price gains are hitting multi-year highs (if not all-time highs as seen in iron ore, copper, palladium etc.) with no deterrent to the current trend. It’s no surprise then if you look at the top performing G10 currencies against the USD this year – commodity-based currencies such as CAD, NZD and AUD all make the top five.
There’s been a substantial growth in demand across the commodity complex, as major central banks continue to run with accommodative policy measures and vaccination rates climb, improving global mobility. China’s outsized recovery alone, has bolstered its consumption to pre-pandemic levels supporting the pickup in energy and metals markets. Australia in particular, has been a beneficiary of China’s rebound as its core exports to the nation including iron ore, coal and wool provide a boost to its trade surplus.
Across all major currency pairs, CAD has been the strongest performer against the dollar gaining +5.5% in 2021 thus far. A number of factors are contributing to its strength – strong wave of economic data that is beating consensus estimates (recent inflation print came in at +3.4%), convergence with the US on the vaccine rollout and the unwavering growth in commodity markets. The Bank of Canada publishes a commodity price index based off 26 commodities produced in Canada and sold globally. Year-to-date, the index is up a staggering ~30% to 7-year highs. Although oil prices have always been a key driver for CAD, other base metals and raw materials have also contributed strongly to recent loonie appreciation.
Unlike the Bank of Canada, which was one of the first major central banks to pull back on its pandemic related QE initiatives, the Reserve Bank of Australia (RBA) and Reserve Bank of New Zealand (RBNZ) continue to maintain their accommodative stance with the RBA not expecting to raise rates until 2024. The ongoing dovishness from both central banks does come as a bit of a surprise, given the strong rebound in economic recovery across both nations – unemployment rates continue to track lower with Australia expected to revert to pre pandemic levels in 2021, New Zealand’s core inflation is in line with the RBNZ’s target and commodity export prices continue to rip higher.
AUD and NZD
Both AUD and NZD are up +1.3% and 0.8% vs the dollar this year with strong commodity prices providing a boost to the antipodean currencies. Local commodity indices on both AUD and NZD, show a respective year-on-year increase on a core group of commodities of 34.7% and 32.5% respectively. The Australian index is largely driven by bulk commodities (iron ore, coal) whereas New Zealand’s index is mainly driven by its largest export, dairy (up 41.3% YoY). Similarly, the broader Bloomberg Commodity Index, of which over a quarter of the make up is metals (remainder being energy and agriculture) is up ~24% since the onset of the pandemic. Despite this unprecedented rise, its possible that the full extent of price increases is yet to be fully baked into the currency strength.
Correlation with Commodity Index
From the three currencies, AUD currently has the strongest correlation (based on daily % change over a 40-day cycle) with the Bloomberg Commodity Index at 39%. The respective NZD and CAD correlations trail slightly at 30% and 36% respectively. Interesting to note is that these correlations were much higher and averaging ~60% earlier in the quarter and quite reactive to commodity headlines. Its not uncommon to see correlations with commodity-based currencies lag at times, especially when other market factors are at play. Look at CAD and crude oil prices – its often we see the relationship breakdown between the two. In fact we’ve seen a steady decline in recent weeks and CAD seems unphased by the recent leg lower in crude oil prices, given other core prices remain buoyant i.e. agriculture, forestry, metals etc.
With the global recovery advancing, central banks maintaining expansionary policy measures and a continued rise in commodity prices, commodity-based currencies seem well positioned to prosper. As other market factors subside and correlations with core commodity prices move back to their average range, increased export prices will weigh positively on trade balance which in turn could directly influence currency strength.
With increased global mobility however, it’s also important to factor in price elasticity on certain goods – take iron ore for example, China is currently reliant on Australia’s production however is looking at measures to moderate the market through either diversification (60% of iron ore imports come from Australia) or investing in / exploring alternatives for its steel production. Lastly, as a stronger currency can weigh on local exporters, central bank expectations will play a key part in sizing the commodity growth impact on the home currency.