AUD, NZD and CAD need support from commodity prices now
Commodity FX (AUD, NZD, CAD) has risen against the USD since early May despite pressures on commodity prices. This raises the following two questions: what triggered the rally? And is it sustainable?
Part of the appreciation is related to the “weak dollar” factor. But this alone is not enough to explain the rally as AUD, NZD and CAD. The explanation can be traced back to idiosyncratic (rather than global) factors, which have led the market to price in an earlier start of the tightening cycle – mostly in Canada and Australia.
The Canadian economy has enjoyed an acceleration in job gains (driven primarily by full-time jobs). The growth recovery has become more diverse and the BoC has shifted its stance to suggest that it will be assessing whether all of the considerable monetary policy stimulus in place is still required. The CA 2Y yield has risen to 0.93% (its highest level since December 2014), pushing CAD higher in tandem. The rates market is now pricing in nearly two 25bp hikes in 12M and a 90% likelihood of three hikes in total over the next 2Y. In Australia too, labor market improvement has accelerated, suggesting reduced spare capacity. Combined with what was (and still is) benign monetary policy expectations, this has led AU 2Y yields to rise by about 11bp over the last one and a half months. Finally, in New Zealand the kiwi outperformance seems to be more related to milk prices holding up better rather than a repricing of monetary policy expectations. The fact that NZD had lagged in the first 4-5 months of the year might have played a role in the rebound, as well as the slightly hawkish shift by the RBNZ (which was, however, more recent).
Regarding sustainability, we think monetary policy tightening expectations are now more aligned with fundamental reality (though still a bit low in Australia) and are largely reflected in FX. In this regard, this element of support seems to have been exhausted. What is needed to turn the rally into a sustainable appreciation is a convincing rebound in commodity prices. Recently, some of the base metals have started to look firmer and we expect the recovery to broaden (on account of global growth holding up well).