A screen displays a picture of Chinese President Xi Jinping next to exhibits showing medical workers’ fight against the outbreak of coronavirus (COVID-19) at the Museum of the Communist Party of China in Beijing, China on November 11, 2021.
Carlos Garcia Rawlins | Reuters
China̵[ads1]7;s zero-Covid policy and broader economic circumstances could weigh on currencies that should reap the benefits of higher commodity prices, strategists at BMO Capital Markets have suggested.
Although commodity prices have risen so far in 2022, with Brent oil on Wednesday reaching its highest price since October 2014, commodity-based currencies such as the Norwegian krone and the Australian, New Zealand and Canadian dollars have been relatively subdued.
From Friday morning in Europe, the Australian dollar was down 0.9% and the kiwi by 1.45% against the dollar so far this year. The Canadian dollar was also down 0.9% so far this year, while the US dollar had risen 0.55% against the Norwegian krone.
“What we usually expect to see is the New Zealand dollar rising along with commodity prices and Aussie prices rising along with base metals, but so far this year both Aussie and Kiwi are down – get this – against the euro and yen,” Greg Anderson, BMO’s global head of FX strategy, said in a podcast last week.
Anderson noted that central banks in these commodity-driven economies have been less hawkish than the US Federal Reserve so far this year, but suggested that this only provides a partial explanation for this divergence between commodity prices and commodity currencies.
He pointed out that the two-year exchange rates, a type of derivative that is a key barometer for currency strategists, for the Australian and Kiwi dollars had underperformed the US dollar, which would give weight to the hypothesis that deviations in central bank policy are a factor.
However, the Canadian swap rate has performed very similarly to the US, so this does not explain why the CAD has not collided with the oil, Anderson claimed, adding that a further mystery is how the AUD and NZD lose ground against the euro and yen. , when the exchange rates for both are approximately flat.
European head of currency strategy Stephen Gallo suggested that ripple effects from China could contribute to the performance of commodity-based currencies in developed markets.
“We know that China is implementing its zero-covid strategy. It has implications for both supply and demand, but it is conceivable to eat into China’s demand for certain raw materials,” Gallo said.
“We know that there were power outages and factory closures late last year, the real estate market is clearly in a downturn, and we also know that politicians do not add large amounts of fiscal and monetary stimulus, even though they have taken a easing bias.”
Gallo noted that international trade data from China show evidence of lower nominal growth rates for certain commodity imports, while import growth has been more subdued than export growth.
“Is the growth backdrop in China being transferred to commodity-based currencies? Yep, possibly it is. Can China’s economic backdrop contribute to a slowdown in global inflationary pressures later this year? Possibly, but we do not know for sure,” he added.
In the medium term, Gallo suggested that the Chinese government’s Made in China 2025 initiative, which aims to reduce China’s dependence on foreign technology imports and invest heavily in domestic innovation, could permanently change the way Chinese demand affects global currencies.
However, it is difficult to determine to what extent the implementation of this policy has been included in current price fluctuations, he noted.
“Perhaps the Chinese economic backdrop has only a partial effect on commodity prices because we see oversupply in other parts of the world helped by very loose monetary policy and, more importantly, very loose fiscal policy,” Gallo said.
“Maybe it’s also an element of the green transition built into energy prices and base metals as well. Maybe the equilibrium prices of certain commodities are simply changing.”
Anderson suggested that the equilibrium price for many commodities would be “semi-permanently higher” through the shift in demand from the green transition, especially in those such as base metals, which he said would benefit metal-dependent currencies such as the South African rand and the Chilean peso. .
“Buy the dip”
In terms of current trades, Anderson advised investors to look for “buy dip” in the AUD-JPY currency pair.
“From both a commodity price and an interest rate differential perspective, the pair should have increased, but it has not. I will still look for a position for a move back to 86 or so by the middle of the year in the Aussie yen,” he said.
Meanwhile, Gallo proposed supporting the euro to move lower against the Canadian dollar, a trade he said was supported by three key factors.
“Firstly, you have higher oil prices, which amplifies the effect of the increase in natural gas prices. Secondly, net trade. The euro area registered its first trade deficit with the rest of the world in November last year in almost a decade.” he said.
The third pillar of support is the expectation that the divergence in monetary policy between the extra dove-like European Central Bank and the slightly more hawkish Bank of Canada may have further run.
“I do not think it is a large amount, given what has already been priced in for the Bank of Canada, but I think there is still a little more left. I think the Euro-CAD can take a stab at the high 1.30s before the cycle ends, “he added.