LONDON (Reuters) – Talk of a commodities “super cycle” and gains in prices from iron to copper have brightened the outlook for resource-linked currencies, but the tide hasn’t lifted all boats, with emerging market currencies struggling to keep up with developed peers.
Emerging currencies have been at the sharp end of a recent rise in U.S. Treasury yields, which sparked a shakeout across global markets.
Below are four charts showing the connection between commodities and currencies and how current moves compare to previous episodes.
1/ TAKING STOCK
Commodities from oil and iron ore to coal and copper play a crucial role in determining the future outlook for currencies like Russia’s rouble and South Africa’s rand.
After they hit troughs in 2020, gains have been eye-watering: oil prices have more than tripled since the Saudi-Russian crude war saw prices drop below $20 per barrel.
But a mix of slower vaccination rollouts, fading growth prospects, rising debt burdens and geopolitical tensions have hamstrung currencies across many emerging markets.
“That’s just simply a reflection of the fact that domestic risks, and risk to the pace of domestic recovery in those EM commodity currencies are greater,” said Aaron Hurd, senior currency portfolio manager at State Street (NYSE:STT) Global Markets.
“You’re in with domestic risks, and I’m specifically referring to fiscal risks, and debt levels are much higher.”
Graphic: Currencies and commodities – https://fingfx.thomsonreuters.com/gfx/mkt/jznpngdewvl/currencies%20and%20commodities.JPG
2/SUPER CYCLES PAST AND PRESENT
Compared to previous super cycles, emerging commodity currencies have got off to a markedly slower start, found Morgan Stanley (NYSE:MS).
In the commodity rebound immediately following the 2008 global financial crisis, and after rallies starting in late 2010, 2014 and 2015, the recovery phases lasted around 21 weeks.
In each case, an average 15% rise in commodity prices resulted in global commodity currencies rallying around 7%-8% against the dollar and emerging commodity currencies rising by 1%-4% depending on the region.
“At the 21-week stage in the current cycle, commodity prices were also up around 15% but with a far more subdued performance from global FX,” said Morgan Stanley’s James Lord, citing smaller yields, weaker growth and worsening debt sustainability as reasons for the underperformance.
“EM currencies in particular were barely off the floor.”
Graphic: G10 and EM commodities currencies – https://fingfx.thomsonreuters.com/gfx/mkt/xegpbgnyjvq/G10%20and%20EM%20commodities%20currencies.PNG
Positioning data shows investors pulled back from emerging market currencies in recent weeks. Following EM euphoria at the start of 2021, many big banks including Morgan Stanley and JPMorgan (NYSE:JPM) have switched to a more cautious stance.
While overall dollar positions show a large short bet of $29 billion, a look below the surface reveals a big difference in positions.
For example, hedge funds are holding their biggest short bet in four months against the Brazilian real while net long bets on the Australian dollar are at a five-month high.
Graphic: USD index and positions – https://fingfx.thomsonreuters.com/gfx/mkt/gjnvwogygvw/USD%20index%20and%20positions.JPG
However, comparing currencies to average real effective exchange rates over the past five years, emerging commodity currencies are more undervalued than G10 peers, said Francesco Pasole, FX strategist at ING.
“The relatively attractive valuation is one of the factors that makes EM currencies (including the commodity segment) less vulnerable to the rise in U.S. Treasury yields compared to the pre-2013 ‘taper tantrum’ state of affairs,” Pasole said.
Graphic: Commodity currencies REER – https://fingfx.thomsonreuters.com/gfx/mkt/xlbvgxrkkpq/Commodity%20currencies%20REER.PNG
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