According to Richard Franulovich, head of FX strategy at Westpac, there has been notable divergence in the AUD’s two core drivers lately; yield spreads have been trending decisively against the currency while commodity prices have been trending in its favour.
“Australia is not alone. A similar divergence between commodity prices and interest rate differentials is also apparent in New Zealand and Canada.”
“Both NZD and CAD, like AUD, have defied their terms of trade for many months. On commodity prices alone AUD, CAD and NZD are all notably undervalued.”
“Supply-side factors have been important drivers of the rise in Australia, NZ and Canada’s terms of trade, i.e. Vale disruptions in the case of iron ore and OPEC supply restraint in the case of oil. It may be the case that markets are looking through the supply driven gains in AUD, CAD and NZD’s terms of trade. The other factor is that global growth risks remain elevated thanks to trade frictions, despite elevated commodity prices.”
“Against that AUD, NZD and CAD do not offer any yield pick up over the US. The 10yr spread for AUD, NZD and CAD versus the US have converged recently around the -60bp to -75bp range. As a group the three currencies have never offered such a lack of yield relative to the US, with the average spread across all the three currencies the most negative on record.”