Forex Trading Library

A Pending Commodity Currency Rally?

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Next week, the economic news cycle is going to be dominated by the big central bank events, such as the FOMC meeting. But some of the smaller data points could get missed in the shuffle. Among them, some potentially good news for commodity currencies. The AUD in particular could stand out.

Yesterday, the Aussie did particularly well, leading some analysts scratching their heads as to what was going on. There was no major news out of China that would justify a rally. Conversely, crude prices have been moving higher, but the CAD has seen somewhat lackluster performance. It seems like there is something going on in the commodity space that isn’t obvious from a superficial look.

Australia’s winning streak

Australia saw its unemployment rate stay relatively low at 3.7%, which was seen as leaving inflationary pressure on the RBA. But it seems that the reserve bank is still pretty much in a pausing mode. The rate sensitive 2-year yield on Australian debt, however, moved higher through the week. This implies that traders are starting to bet that the Aussie could stay strong for some time to come.

Monday night (or Tuesday morning, depending on where you are in the world) the RBA will publish the minutes of its latest meeting, where it decided to continue the rate pause. Traders will be very keen to see what the views of members were on the potential for raising rates. If the RBA is excessively worried about the economy, then the recent gains in the Aussie could melt away, as the yield on debt would presumably fall. But, if the RBA simply holds the line on inflation, then there could be room for rates to keep rising, and pull the Aussie up with it.

The weight on commodities

To bring in the CAD, one of the issues that commodity currencies have been facing is a persistently strong dollar. This is thanks, in large part, to two factors: First, the generalized worry about economic growth. Second, and more crucial for the recent moves in the currencies, is the expectation that commodity central bankers will ease off on the rate hikes before the Fed.

Since there is broad speculation that the Fed has reached peak rates – only a minority of traders see another rate hike this year – that means the BOC and RBA won’t raise rates. According to the theory that commodity currencies have to ease up on the tightening first. But, speculation has been growing that the Fed might not be done with rate hikes. If the US manages to avoid a recession, and inflation has been ticking up, then the Fed could resume tightening. And that would give more room for rate hikes from commodity currency central banks.

Bucking the trend

Typically, when the Fed is expected to hike, the dollar gets stronger over the commodity currencies. But with the economic data from Australia remaining strong, there is reason to speculate that the RBA might have to go back to hiking again. That helped explain the higher Aussie recently.

The CAD might be in a similar situation soon. Not so much because the economy is outperforming, but if inflation in the US keeps picking up, it could spill over into Canada. If the Fed has to raise – or keep rates elevated for a really long time – then the BOC might have to tighten more than the market currently expects. That might imply a turnaround in the CAD, particularly if energy prices stay elevated in the coming months.

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