Commodity currency play

May 19, 2016 12:00 PM

Commodity currencies made a sharp recovery in Q1 with the help of the stabilization in metals and energy prices, as well as an increasingly dovish Federal Reserve. The currencies of Australia, New Zealand and Canada are among the notable gainers vs. the U.S. dollar since the start of the year. Rather than chasing a moving train, traders should explore opportunities in related forex commodity plays.

The Reserve Bank of Australia has kept its overnight rate at 2% since May 2015. During that period, the Aussie had been a tale of two halves: Tumbling 10% in trade-weighted terms between May and October and rebounding more than 8% from mid-Q4 of last year to end of Q1 2016. 

The Aussie fared among the top performing currencies against the greenback in Q1 despite forex jawboning from the RBA. The Aussie found its way higher after the April meeting, when the RBA acknowledged the improvement in financial market sentiment, in another sign that it has grown more sanguine. Since March, Aussie macro data has been neutral to positive, with GDP growing at a higher than expected 3% in Q4 2015, accompanied by a tightening labor market and a rise in business confidence. Inflation was at the low end of the RBA’s target, but not low enough to justify a Q2 easing. 

Growing chatter of a New Zealand Central Bank (RBNZ) rate cut to 2% at its April meeting has begun to weigh on the kiwi in early Q2. Weakening export prices, currency appreciation and failure of banks to pass on the surprise March rate cut are  the culprits.   

New Zealand’s Global Dairy Trade Price Index is down 12% year-to-date as of mid-April, adding pressure on the nation’s vital dairy industry. The RBNZ noted in early April that here has been “little additional upward pressure on wages.” A possible obstacle to an April RBNZ rate cut is the emerging strength in the housing market. But as long as the Fed remains on hold, the kiwi, being the highest yielding currency in the developed world, is a major candidate for pulling another aggressive rally, which may force the hand of the RBNZ. 

AUD/NZD traders are dealing with RBA and RBNZ policy rates at 2% and 2.25% respectively. More importantly, the spread between yields on Australia’s 10-year government bonds and their New Zealand counterpart (AUD - NZD yields) is -0.4%, rising from -0.92% lows in December 2014, which was the lowest since 2001. Currency markets are primarily concerned with the prospects of movements in relative changes in monetary policies and yield differentials. Thus, rather than the absolute negative differential between Aussie and kiwi 10-year yields at -0.40% or the -0.25% differential between RBA and RBNZ policy rates, traders focus on the trend of these differentials. “Reversal down under,” illustrates the rising trend of both policy and yield spreads between Australia and New Zealand, which correlate positively with the AUD/NZD rate.  

In addition to a break in the long-term downward trendline, the AUD/NZD monthly chart forms an inverted head-and-shoulders formation where the shoulders rest along the 1.05 support level.  A weekly chart shows a golden cross triggered by the 50-week moving average crossing above the 100-week moving average for the first time since April 2012. Resistance emerges at neckline and 200-week moving average at 1.1340 neckline. 

The monthly chart shows a breakout from the March 2011 trendline resistance, which could pave the path to 1.1570, followed by 1.2000. A long AUD/NZD position is appropriately backed by technical and fundamental dynamics.

About the Author

Ashraf Laidi is chief global strategist at City Index-FX Solutions and author of “Currency Trading & Intermarket Analysis.” His Intermarket Insight appears daily on AshrafLaidi.com.