the recent oil price rally has fueled a
recovery in commodity currencies like
the Canadian and Australian dollar but
has the market got ahead of itself with
this rally and commodity currencies one
man who thinks so is Stephen say well
global FX strategist at BNP paribas
Stephen what is it that has caused the
rally in recent commodity price
currencies well we think it really gets
down to one point and that's the Chinese
recovery certainly if we look at the
tail end of 2015
expectations for Chinese growth were
fairly muted but actually what's
happened in 2016 is that growth has
exceeded expectations that's led to
stronger demand for commodities and
we've seen quite a nice rebound led by
oil but also other commodities are
specifically things such as Idol okay so
if we take a look at your first chart it
shows us the Australian dollar which is
a commodity currency driven by iron ore
prices and it's showing basically that
the red line shows the actual spot rates
of the foreign exchange rate compared to
the US dollar and then we have the BNP
paribas model for number that shows the
blue number that shows basically it's
currently undervalued so why do you
think that is sure well I should
highlight it so the blue line here is
one of our flagship models it's called
BNP Paribas clear it gives a medium-term
equilibrium level of a currency what we
think has happened here is that the
Australian dollar is currently
significantly higher than the
equilibrium level would suggest I think
that's - there's two factors there one
is the commodity prices have accelerated
quite significantly we don't think that
is sustained so we think that pull back
the falls back secondly until very
recently the Reserve Bank of Australia
had kept interest rates very high as
well - they've started to ease policy
now and we're starting to see the
Australian dollar converge back to the
level signaled by the model okay so if
we take a look at the second chart that
you've brought out the second chart
shows us the market position and how
it's changed so we've had the this is
the exchange rate with the Canadian
dollar versus the US dollar and the
Australian dollar of the US dollar
Canadian obviously been an oil fueled
currency as well and we can see that the
positioning has changed in the market so
we've gone from quite a strong short
position at the beginning of the year to
quite a strong long
so do you think the market has got it
wrong or why why has a switch well this
is interesting if we look at the history
of these two commodity currencies and
remember the zero line here is a neutral
position you can see that for the past
12 to 15 months the markets pretty much
exclusively held a short position that
changed quite dramatically from the
beginning of 2016
I think driven by the commodity price
rally we're now at a level where the
market is we would say quart long of
both of these currencies the reason we
say quart is that if commodity prices do
fall back which they're starting to
already and it's consistent with our
expectations the market will then
scramble to reduce these long positions
and that will accelerate the move to the
downside for both the Australian dollar
but also the Canadian dollar okay so
then if we look at your third chart when
we talk about where the market is and
where you might suggest that people
could take advantage of the trend that
you think is coming we take a look at
the Australian dollar and compare it to
the euro so that's the red line here and
the blue line is showing us the two-year
interest rate swap spread which
traditionally there is there is a
relationship between those although we
have seen some gaps in a few points so
so what what is this chart telling us
well certainly the underlying philosophy
here is that there's a very strong
relationship or correlation between
short-term interest rate movements and
currencies secondly traditionally the
Australian dollar tends to be quoted
against the US dollar and that's what
the original model told us that
equilibrium lies to the downside around
67 cents that's a great trade over the
medium term but in the short term we
think the euro will continue to do very
well so one of the favored trade
recommendations we have is long the Euro
against the Australian dollar and this
chart or the relationship here backs
that up
very clearly you can see the blue line
which is the interest rate differential
is moving significantly in favor of the
euro and that's pushing the euro versus
the Australian dollar higher what you
can also see is the interest rate is
telling us there's more to go on the
upside so we think being long the euro
versus the Australian dollar is a very
good trade recommendation okay
and then if we take a step back and look
at what investors are watching so I mean
we've had stronger recovering commodity
prices we've had a weakening expect
of the Fed and and what the rate hikes
might be and we've had some recovery and
sort of the Chinese or some some
pleasant surprises or around Chinese
economic data in the past few months
that have been fueling this what are the
things that if an investor had to pick
one or I guess at most two things to
watch of when this might turn what would
those be okay well if I had to name two
factors here particularly the case of
the Australian dollar I'd named the
following two two points one what
happens to iron ore prices does it fall
back or do they fall back as we
anticipate and secondly what happens on
the interest rate front is the Reserve
Bank of Australia likely to cut interest
rates again we think they do potentially
as early as June if either or both of
those factors happen the Australian
dollar will weaken thanks very much
after twenty-one years of service Saudi
Arabia's veteran oil minister Ali
al-naimi was unceremoniously removed
from his post on Saturday as part of a
wider government