Stepping back from the day-to-day market noise, we remain long-term bulls on the commodity currencies.
O ne way to value commodity currencies is to compare their real effective exchange rates against their terms of trade. Despite being near multi-decade highs, the Canadian, Australian and New Zealand dollars are trading at a discount to the levels implied by their terms of trade.
There are many potential sources of upside in the commodity currencies.
First, the current level of commodity prices and terms of trade will drag these currencies higher over time to simply close the undervaluation gaps. The “mean reversion” suggests there is about 10% upside from today’s levels.
Second, assuming that our long term view on commodities is correct, the terms of trade will rise further, placing additional upward pressure on the fair value of the commodity currencies.
Third, there is the potential for overshoots. Canada, Australia and New Zealand are small economies. If global investors (both private and public sector) want to increase their allocation to these relatively small and illiquid currencies, they can very easily overshoot their fundamental values.
Finally, the resource boom will boost domestic incomes and spending, which will force their central banks to keep interest rates relatively high. In a world where the Fed, ECB, BoJ, BoE and SNB have policy rates near zero, investors will be attracted to the higher interest rates in Canada, Australia and New Zealand.
Bottom line: Our Foreign Exchange Strategy service remains a long-term bull on commodity currencies.