Countries that are rich in a particular resource and export that commodity as a primary income generator relative to their economy are known as having commodity currencies. Australia, Norway, or New Zealand, for example, have currencies that are historically correlated with the prices of respective commodities.
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2022 proved to be an aberration from commodity currency correlations. For much of the year, global inflation and central banks policy dominated the headlines and drove trading activity. Many commodity currencies suffered this year when prices for oil and other raw materials fell from their 2022 peaks amid expectations that central banks' fight against inflation would hurt global growth and slow demand for commodity exports.
In addition to heightened volatility, stronger than expected economic data has provided tailwinds for the U.S. dollar which has driven many commodity currencies to underperform. Compared with other central banks, the Federal Reserve appears to still be more aggressive which could put further pressure on global commodity currencies. The Fed has started to show signs that they may be in the final stages of their quantitative tightening, which could lead to a weaker U.S. dollar and opportunity for global currencies to move higher.
Australian Dollar Undervalued
Some commodity currencies have enjoyed strong runs against the dollar this year. The Australian dollar, according to Deutsche Bank, is undervalued against the U.S. dollar by about 20%.
Australia is a major producer and exporter of iron ore, gold and other metals. As gold and metals have retreated from their early 2023 highs, so has the AUD/USD exchange rate. For commodity currencies, the cheaper commodities get, the currency generally follows suit. Given the historical correlations in price between the Australian dollar and gold/metals, it is not surprising that they would experience similar volatility and price changes. In the volatility chart below, it is easy to see how strong the correlation is between the AUD/USD exchange rate, and gold and metals.
Energy Prices and the Krone
Norway is one of the largest oil and gas producers in the world, which causes its currency to generally trade based off energy prices. Since the start of the Russia-Ukraine war, the krone has been strong due to increased energy prices. In August 2022, the EUR/NOK conversion traded at levels that it had not seen in over three years because of record high energy prices. Although the krone has strengthened as of late against the Euro, it has continued to weaken in 2023 against the dollar. The Norwegian krone is the second worst performing G10 currency against the U.S. dollar this year, down nearly 3% against the greenback and undervalued against the U.S. dollar by more than 30%, according to Deutsche Bank. With energy prices back on the rise, one would expect to see the krone strengthen against the U.S. dollar, but that has not proven to be the case yet.
Commodity currencies have mostly regained their correlations after a difficult 2022 that was dominated by central banks combating inflation by raising interest rates. As we near 18 months since the first interest rate hike by the Fed, inflation numbers continue to fall, and it appears the end of the quantitative tightening cycle may be near. If and when interest rates begin to decline, the U.S. dollar could weaken.Commodity prices and their respective currency pairs would be helped by such an event, and may require it in order to enter a new phase of growth.
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