Commodity-linked currencies vulnerable to global slowdown

Allan Robinson

The Canadian dollar, like other commodity-linked currencies, is vulnerable – especially if traders who have been betting on an inflation-driven rally in commodity prices change their tactics on fears of a global slowdown.

The rally of the loonie to par with the U.S. dollar is off for now, said Aaron Fennell, a futures broker with Lind-Waldock, the Canadian division of MF Global Canada. “It appears as if we are headed into a second-dip in the recession, especially if the European problems are not contained.”

Mr. Fennell doubts that the European political climate will allow a successful resolution of its problems, and that could lead to continued weakness in oil, base metals and other commodities. “I think it [the investment climate] is changing for at least the next year or so.”

What are the expectations?
Until recently, almost everything seemed to be going right for the domestic economy. The leading indicator, which is due to be released on Thursday, soared 169 per cent from the depths in early 2009, but economists forecast it will drop back to 0.7 in April from 1 in March, according to a survey of economists by Bloomberg. The indicator comprises 10 components that lead to cyclical activity in the economy and reflect all major categories of the gross domestic product.

Speculative capital is getting out of risk assets such as industrial commodities, which could lose a huge percentage of their value, Mr. Fennell said. “Within the next year, the price of our major products is going down.”

How will the market react?
Compared with the other commodity-linked currencies, the Canadian dollar should do better, given the economy’s close ties to a recovering United States, a strong fiscal position and the prospect that the Bank of Canada will be raising interest rates, Mr. Fennell said. The weakness in the loonie increases the odds of a rate hike, he said.

The Canadian dollar plunged as much as 1.8 per cent against the U.S. dollar Wednesday before recovering to end the day down only 0.38 per cent,

The critical aspect of currency trading is the sharp drop in commodity-linked currencies, suggesting worries have increased about the prospects of global growth, said Camilla Sutton, a currency strategist with Scotia Capital Inc. During the past five days, the Mexican peso, the South African and the Australian dollar slid 3.8 per cent, 3.9 per cent and 5.4 per cent, respectively, against the U.S. dollar, while the Canadian dollar is down 2.4 per cent.

Problematic for stock market investors is that each of those currencies performed much worse than the embattled euro, which fell only 1.8 per cent against the U.S. dollar after bouncing back 1.5 per cent on Wednesday.

“The combination of decreasing expectations for a June 1 Bank of Canada rate hike, (now just 50 per cent to 55 per cent priced in), escalating fears over the impact of events in Europe on global growth, dropping oil prices and risk aversion have left the Canadian dollar [to the U.S. dollar] vulnerable,” she said in a report to clients.