Higher commodity prices led to rallies in commodity currencies such as the Australian and Canadian dollars. What to expect in the second half of the year?
The stock market has rallied ever since effective vaccines against the Covid-19 virus were developed. Meanwhile, the US dollar weakened against most of its G10 peers.
The move lower in the US dollar was particularly visible against commodity currencies. The Australian dollar and the Canadian dollar rallied during the pandemic, and have only recently given back some of the gains.
Despite the recent weakness, commodity currencies will likely find bids on every dip. Higher oil prices support a strong Canadian dollar and put pressure on inflation. Higher inflation, on the other hand, supports higher commodity prices, which, in turn, support the Australian dollar. Australia is a big exporter of raw materials, and Australian export prices seem durably strong.
Commodities: A Hedge Against Inflation
Commodities are alternative investments. They are mainly used as a hedge against inflation, and commodity currencies represent just another way of gaining exposure to the commodity market.
The recent weakness in the AUD/USD pair started from the moment the Fed issued its hawkish statement at the June meeting. More precisely, the interest rates dot plot in June showed more rate hikes in the future than the market expected. As such, the US dollar gained across the board, but commodities held close to their highs, as seen (for example) in the price of oil.
The Reserve Bank of Australia is facing inflation pressures, just like any other economy in the developed world. The labor market recovered and the economic growth rate rebounded as it has in other advanced economies.
In other words, the commodity currencies’ future strength or weakness will not depend on local economic performance but the future path of the US dollar and the price of oil.
If the Fed manages to convince markets that higher inflation is transitory, we should see this reflected in a falling oil price. Until this happens, commodity currencies remain a buy on every dip.