Bear market for commodity currencies probably has further to run
The outlook for commodity currencies continues to look bearish due to over-supply, potentially slowing Chinese demand and the threat of a US interest rate rise.
AUD, NZD and CAD have all been sliding lower recently reflecting weaker commodity prices. The major ones such as iron ore, oil and copper have all seen significant price set-backs, which effects the earnings of the countries, which produce and export them.
But there could be further currency weakness to come particularly for Australia and New Zealand. Both benefited from their yield advantage in carry trades – but the central banks of both countries have been undermining that. Most recently the Reserve Bank of Australia has once again been calling for a weaker AUD and a while back the Reserve Bank of New Zealand shocked markets with a surprise rate cut.
In Australia signs of economic weakness might be spreading beyond mining towards other sectors. This also impacts New Zealand as Australia is it's main trading partner followed by China (Australia's number one rade partner). The dairy sector – a key exporter for New Zealand – has suffered from softening prices. Meanwhile, the pace of demand for industrial commodities has been slowing in China. It triggered the most recent commodity super-cycle, which may now be unwinding.
AUD/USD – closing in on key support level
Commodity currencies could still sink even if USD bull market is over
The other key consideration for the commodity currencies is the USD. Whereas there is a bias towards easier monetary policy in many commodity producing countries the opposite is true of the US thanks to a good run of jobs numbers. It looks likely that the Federal Reserve will raise rates within the next twelve months with the UK not far behind.
The situation for Canada is a little more nuanced. It has been negatively impacted by the fall in energy prices, but it has a more diversified economy and the Bank of Canada is confident that a rebound is just around the corner, which would cancel out the need for any extra monetary stimulus (though it can't be ruled out yet).
However, there are concerns about recent US economic sluggishness. The US buys 90% of Canada's exports. It's also a major consumer of commodities generally. If it is entering a prolonged spell of sluggish growth then that will impact commodities demand and may indefinitely delay a US rate rise.
A more bearish event for commodity currencies is a US interest rates rise. Though this should be seen as good news. It suggests the economy and monetary policy are normalising. But it will create considerable uncertainty as to how the US economy deals with it as it's been such a long time since Fed rates have been raised.
Nonetheless, such are the negative dynamics for commodity currencies that they could still lose ground against USD even if the larger USD rally is coming to a conclusion.
For AUD/USD a move below support at 0.7533 – not seen since 2009 – looks entirely possible and could go all the way down to 0.7000. NZD/USD by June 11 had already breached 0.7000 and could be on track to revisit levels of 0.6500 last seen in 2009. USD/CAD is near historic highs of 1.2835 and if those are cleared then 1.3000 could be on the cards – last reached in 2004.
By Justin Pugsley, Markets Analyst MahiFX