Central bank talk moves currencies now, not commodity prices


Commodities Obsolete in Models Yielding to Fed, ECB

By Cecile Gutscher
Bloomberg News
Friday, July 4, 2014


Commodities are getting a demotion from foreign-exchange strategists.

Banks from JPMorgan Chase & Co. to Citigroup Inc. are reducing the weighting given to exports in their currency forecasting models as policy makers tighten their grip on financial markets. Traditional commodity currencies, such as those of Canada, Australia, New Zealand and Norway, have become decoupled from exports by the most in as much as 13 years.

"The breakdown in correlations has been significant," Niall O'Connor, an analyst at JPMorgan in New York who specializes in tracking trends in trading patterns, said by phone on June 25. "It's central-bank talk that's really become the catalyst for price action."

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From the U.S. Federal Reserve to the European Central Bank and Bank of Japan, policy makers are showing little appetite to stop stimulating their economies after the World Bank lowered its global economic growth forecast last month. The delinking of commodity prices and the currencies of nations that rely heavily on exporting raw materials is upending one of the most established relationships in global markets.

The correlation between Australia's dollar and the price of iron ore fell to minus 0.75 yesterday, the biggest disconnect in data going back to 2009. A reading of minus 1 would mean they're moving in separate directions; positive 1 would mean they're in lockstep. Last July, the correlation reached 0.83.

Iron ore accounts for about half the economy of the mineral-rich state of Western Australia and fell last month to an almost two-year low of $89 per dry metric ton.

New Zealand's dollar is this year's best performer in a group of 10 peers tracked by Bloomberg Correlation-Weighted Indexes, strengthening 6.6 percent. The kiwi has rallied even though prices for dairy products, the country's biggest exports, fell 19.5 percent this year, the most since the first half of 2012, an Australia & New Zealand Banking Group Ltd. index shows.

In a sign of policy makers' influence, Reserve Bank of Australia Governor Glenn Stevens prompted the biggest slide in the local dollar in six months yesterday when he said the Aussie was "overvalued." The currency tumbled 1 percent to 93.47 U.S. cents yesterday, and was at 93.53 as of 1:24 p.m. in London.

Like Stevens, many central bankers in both developed and emerging economies are trying to talk down their currencies to make their economies more competitive.

The Reserve Bank of New Zealand this year became the first developed nation central bank to raise interest rates since 2011, boosting the local dollar and blunting comments by Governor Graeme Wheeler that the currency was too strong. The Aussie, attractive to investors because of the country's relatively high 2.5 percent benchmark rate, posted the second-biggest gain in the developed-currency basket at 5 percent.

"What central banks say their policies are matters more than the historical drivers of the currencies," Steven Englander, the global head of Group of 10 foreign-exchange strategy at Citigroup, said in a June 30 phone interview. "The jury's still out whether this is going to be sustained."

Citigroup, the world's biggest currency trader, recalibrated its models for the Aussie away from commodities after Stevens signaled in February a two-year monetary easing cycle was over. Rather than strip exports out entirely, it assigned them a "judgmental underweight" value to prevent historical prices being distorted, Englander said.

JPMorgan also tweaked its models to assign a lower weight to currencies. O'Connor wouldn't provide details.

The link between Norway's krone and oil broke down in May for the first time in more than a decade as this year's 5.8 percent surge in crude failed to prevent the currency tumbling 2.3 percent versus the dollar. The correlation reached minus 0.06 on July 1, the biggest divergence since 2002.

Norges Bank Governor Oeystein Olsen said in June he'd tolerate a weaker krone to boost investment. His Canadian counterpart, Stephen Poloz, insisted in January a lower exchange rate would give an "extra kick" to the economy and reduce the pressure for him to consider cutting rates.

"Among big central banks, it's not too well looked upon to say you're going to set policy around the currency," Greg Moore, a senior strategist at Royal Bank of Canada in Toronto, said by phone on June 25. "So the way central-bank governors talk about it is how the currency influences the economy."

After 10 years of moving in the same direction, the relationship between oil and the Canadian dollar was turned on its head in March, with the correlation reaching minus 0.16 that month, the most negative since 2001.

Nomura Securities Co. Ltd. is another bank that has altered its currency models and, for short-term forecasting, now prioritizes financial flows and monetary policy rather than commodities.

"A lot of investors are completely ignoring oil, which in the past had underpinned the Canadian dollar, and focusing solely on downside risks," Charles St-Arnaud, a senior economist at Nomura in London, said by phone on June 26. "It seems that every currency linked to a commodity price has completely decoupled from their commodities."

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