Re-Assessing The Commodity-FX Relation

The rally in commodities has benefited G10 commodity FX more than EM FX so far, due in part to the UST sell-off. Looking ahead, long term undervaluation may help RUB reap more benefits from a 2H oil rally and help BRL weather a decline in iron ore, which should hit AUD harder. A continued rally in copper should support CLP, while coal’s FX impact should stay low.

In this article

  • What currencies can still benefit from a commodity rally?
  • Oil (CAD, NOK, RUB, MXN, COP) – Further rallies more likely to materialize in 2H21
  • Iron ore (AUD, BRL) – Prices look unsustainable
  • Coal (AUD, ZAR) – Some weakness could materialize after the winter
  • Copper (CLP) – Room for more short-term upside

Booming commodity prices have accompanied the market’s recent bets on the global recovery. As shown in Fig 1, almost all major commodities saw a sharp increase in the first two months of 2021, led by the well-sustained recovery in oil prices.

Fig. 1 & 2 - YTD performance of commodities and commodity currencies

(Click on image to enlarge)

Source: ING, Refinitiv

We look at the main commodities that normally have an FX impact (oil, iron ore, coal and copper) and their near-term outlook, and then go on to analyse how commodity currencies are positioned to either benefit or be negatively impacted from future commodity dynamics.

As shown in Fig. 1, the two mostly traded precious metals, gold and silver, have been the key laggards, but for the purpose of the analysis of FX impact, we will not discuss those as they rarely have a clear impact on the currencies of those countries that are heavy exporters of those commodities.

What currencies can still benefit from a commodity rally?

So far in 2021, G10 commodity currencies have performed better than EM commodity currencies (Fig. 2). This doesn’t come as a surprise as EM commodity currencies were the vulnerable high yielding segment during the latest UST sell-off (which spilled over into the decline in local bonds).

From a valuation perspective, EM commodity currencies are generally more undervalued than the G10 commodity bloc, as shown in Figures 3 and 4 below. That is particularly evident from the longer term valuation prospective. All EM commodity currencies except MXN present a marked undervaluation to its average real effective exchange rate of the past 5 years (Fig. 4). As discussed in “Timing the Tantrum: The market implications of a big Treasury sell-off”, the relatively attractive valuation is one of the factors that makes EM currencies (including the commodity segment) less vulnerable to the rise in UST yields compared to the pre 2013 taper tantrum state of affairs.

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