Commodity Currencies Need a Break
Ashraf Laidi
The relationship between stocks and commodity currencies of Australia, Canada and New Zealand is taking an usual turn today, whereby equity indices are rising and these currencies are falling behind relative to the rally in EUR, GBP and CHF. One explanation is the weakening outlook for world growth, which is weighing on oil and gold prices. Talk of a potential supply hike from OPEC is sending oil below $93 per barrel while gold struggles just above the $800 figure.
We have already seen this broad weakness in commodity currencies last week after Fed Chairman Ben Bernanke predicted a “marked slowdown” in US Q4 growth. Another possible explanation is that currency traders are cautious from opening fresh dollar shorts ahead of this week’s G20 meeting of finance ministers in South Africa, where US Treasury Secretary Paulson is expected to receive considerable support for the “strong dollar policy”. Specifically, Canadian politicians have grown increasingly vocal in their complaints about the strong Loonie, which caused Canada the biggest burden of this year’s decline in the dollar. Last week, Canada’s Finance Minister Flaherty said he and Bank of Canada Chief Dodge will be having currency discussions with their G20 counterparts.
Considering the aforementioned risks against commodity currencies and our expectations for further erosion in US and global equities, we expect the unwinding of yen carry trades re-emerge against CAD and NZD and to a lesser extent the AUD (because Australia’s fundamentals are powered by an increasingly hawkish RBA).
November 15: Another August 15?
The next bout of equity selling could emerge on November 15, which marks the last day of the 45-day notice period at which clients should notify hedge funds to withdraw their money. With the broader market down nearly 7% since the beginning of the quarter, clients may take some money off the table as was the case in Q3 when August 15th was marked with massive selling across all equity indices. At the open of August 15, the S&P500 was down 5% since the beginning of Q3. Today, the S&P500 is down 5.7% since the beginning of Q4. In this case, we expect renewed rallies in the yen crosses and for the Aussie, Kiwi and Loonie to come under renewed pressure. The fact that the VIX measure of volatility stands at 2-month highs and the S&P500 is below its medium and long term averages (50, 150 and 200 day) underlines lingering preoccupation in the market. Given the technicals in the US benchmark indices and the ongoing repricing of MBS via credit rating downgrades, we expect the indices to retest their August lows. This means that another 5% decline in the S&P500 is in store.
Wednesday’s release of the October retail sales report is expected to show a 0.2% increase following 0.6% in Sep and a 0.3% rise in the core figure following a 0.4% rise. But given last week’s dismal reports on store sales, we do not rule out a decrease of as much as 0.2% in the headline rate, in which case will be the confirmation for Dr. Bernanke that the erosion in housing has begun to show in consumption. A resulting selloff in equities is likely to boost the yen and affirm the aforementioned forecast against high yielding/commodity currencies.
