Since the start of July, the US Dollar index has weakened by almost 2%. This decline has primarily come in the 16 days since the US Bureau of Labor Statistics published the country’s latest annual inflation figure, which stood at 3% for June. With inflation now approaching target levels, markets are expecting the Federal Reserve to conclude its rate-hiking cycle in the near future, with the possibility of a final 25 basis point raise in July. As the USD has weakened in recent weeks, ChAI’s models have interpreted the relative strengthening of several currencies as key drivers for commodity prices. In this week’s blog, we will look at three example commodities and a correlated currency which has changed in value recently, and examine how the slide in USD strength creates opportunity elsewhere.
Commodities and Currencies Before diving into the examples, it is worth explaining why the weakening US Dollar is so important in commodity markets. With many commodities priced in dollars, its decline can lead to an increase in demand for commodities from countries that export them, as foreign buyers can purchase more goods with the same amount of their own currency. Furthermore, when a country's currency strengthens against the US dollar, it means that exporters from that country receive more of their own currency for each unit of the commodity sold in dollars. As a result, a weakening dollar can often lead to upward price pressure in commodity markets while also boosting the strength of currencies which are closely tied to commodity prices.
There are other possible effects, such as the reduced competitiveness of US-exporters in the international market and increased inflationary pressure in the US. Lastly, the weakening dollar must also be set in context with wider economic trends and events, so the theoretical implications on commodity prices of the dollar’s relative weakness will not always be translated into reality.
Copper and Peruvian Sol
Peru is the second largest exporter of copper ore in the world, only behind its southern neighbour Chile, and so the value of the Peruvian Sol is tied to the fortunes of the red metal. Indeed, copper ore constitutes over 25% of the value of Peru’s total exports. The chart below shows the Dollars to Soles exchange rate (purple line) against the cash price for LME Copper (white line), dating back to the start of Q4 2022. Back in November 2022, the US nonfarm payrolls report signalled that the Federal Reserve’s programme of interest rate hikes had started to impact employment and wage inflation statistics, prompting market speculation that the pace of rate hikes may slow. Highlighted by the orange circle, the dollar weakened on this news, with the sol strengthening in comparison as copper prices rose.
USD/PEN vs LME Copper, shown in Driver Detail chart in ChAI
Over the past six weeks, the sol has gradually been strengthening against the dollar while copper prices have drifted higher, climbing from $8000/t in late May to near $8,600/t at present. The green circle highlights the market reaction in early July to comments made by Fed officials that the rate-hiking cycle is almost finished, following which there was a clear move in both copper prices and the dollar strength. At present, ChAI’s models view the strengthening sol as a bearish driver for copper in the mid-term. However, it is important to consider that copper markets in 2023 are more likely to be driven by demand, or continued lack thereof, for the metal from China.
Natural Gas and the Norwegian Krone
Since Russia’s invasion of Ukraine and the restrictions on Moscow that followed, Norway has been elevated to become Europe’s primary source of oil and gas. As the continent scrambled to refill its gas reserves ahead of the 2022/23 winter without the usual Russian imports, Norway took on a central role. As a result of the increased importance of European gas prices for Norway’s economy, the downward drift of natural gas prices this year has weakened the Krone. Since mid-December, highlighted by the orange circle in the graph below, TTF prices have steadily fallen over the ensuing seven months. Conversely, the krone follow a path of depreciation up until late May, highlighted in green, where its weakness against the dollar peaked.
USD/NOK vs ICE TTF Prices, shown in Driver Detail chart in ChAI
Over the past two months the krone has regained some strength against the dollar and, crucially for Norway, against the euro. Consequently, ChAI’s models currently view the recent strengthening of the krone as bearish for TTF prices over the next quarter. However, with much of Europe currently experiencing severe heatwaves and droughts, prompting higher demand for air conditioning, it is possible that gas demand will drive TTF prices up and simultaneously strengthen the krone.
Soybeans and the Brazilian Real
Brazil is rich in resources, but one commodity market in which it is becoming increasingly dominant is soybeans. Brazi; has overtaken the US to become the leading exporter of soybeans globally, and has been forecast to produce a record harvest of 155 million tonnes this year, more than 30 million tonnes more than the US. This ballooning role in the global market has led to soybean prices becoming increasingly tied to the value of the Brazilian real. As the orange circle in the graph below shows, when prices for grains and oilseeds spiked in early 2022 following Russia’s invasion of Ukraine, the dollar to real index moved in an almost exact inverse correlation to the price of CME soybean futures.
USD/BRL vs CME Soybean prices, shown in Driver Detail chart in ChAI
More recently, as shown by the green circle, a similar pattern of increasing soybean prices and a strengthening real has emerged again. ChAI’s models currently are interpreting the real as a bearish driver on the long-term horizons, however it is likely that the real will continue to appreciate as soybean prices rise before the two lines converge again. The extent to which China’s demand for soybeans this year dents the record levels of supply will be key to determining when soybean prices fall again.
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