This year has seen a rapid decline in commodity prices the world over. Commodity currencies such as the Australian Dollar (AUD), New Zealand Dollar (NZD) and Canadian Dollar (CAD) have all experienced fluctuations in response to the commodities a downturn. So how exactly do commodity values affect a nation’s economy and currency?
The Australian Dollar (AUD) Commodity Currency and Iron Ore
With iron ore Australia’s biggest export (and China its largest trading partner), any decrease in Chinese demand will cause the price of the commodity to fall. The pace of economic expansion in China has slowed of late, causing reduced sentiment for the Chinese Yuan (CNY) and a softer ‘Aussie’ exchange rate.
Excess global production of iron ore throws off the supply/demand ratio and prices have to lessen for competitive purposes. At the moment, a hot topic in the market is the effect that falling iron ore values will have on Australian economic growth. Moody’s Analytics recently stated that the collapse in iron ore prices (with values falling almost 40% this year) could lead to a downgrading in the ratings of producers.
The Impact of a Credit Ratings Agencies on Currencies
So what does that mean if a credit rating agency changes the ratings of producers? Moody’s stated in September: ‘The currently weak iron ore prices will exert a direct negative impact on its rated Australian producers over the next 6-12 months.’ The fall, initially, is likely to impact the Australian Dollar and make it softer against other majors. Moody’s uses a scale from Aaa (the highest) to C (the lowest) to judge how financially secure a country or company is. Moody’s researches the subject and evaluates the amount of financial risk they hold. Already the depreciation of iron ore prices has hit the economy hard, with miners and contractors, construction firms and airlines all feeling the effect.
The economy is expected to feel the consequences of the drop for the next six to twelve months. If the surplus of global iron ore continues to grow, Moody’s will most certainly downgrade. Moody’s stated: ‘Downward rating actions for iron ore producers could result as Moody’s reassesses the impact of a protracted pricing weakness.’
Moody’s continued: ‘Key assumptions underlying the aggressive supply push by the major producers include the idea of maintaining market position given the number of projects that could be undertaken, that the lower costs associated with higher volumes mitigates the degree of price decline, and that high-cost producers will need to exit the market.’
The New Zealand Dollar (NZD) Commodity Currency and Dairy Prices
Let’s now assess the impact of falling dairy prices on Australia’s close neighbour, New Zealand. Since February, dairy prices have fallen by almost half (48%) causing massive losses for the ‘Kiwi’ commodity currency. Moreover, the prospect of dairy prices rising in the near future is slim. Director of dairy research in New Zealand and Asia for Rabobank, Hayley Moynihan, commented: ‘However, while a bottom appears to have been reached for New Zealand and Australian export prices, market rebalancing will be a slow process and price recovery looks some way off.’ Confidence amongst ‘Kiwi’ dairy farmers fell to a two year low in September—a factor that can directly affect the commodity currency. The report showed a massive 37% of farmers had adopted a negative outlook for the next 12 months and 42% expected the current poor price conditions to remain.
The Domino Effect of Waning Commodity Demand
So, a lack of demand causes prices to fall, a drop in prices triggers a loss in confidence, a loss in confidence sees investor sentiment wane, and a weaker commodity currency is the result. The domino effect of weaker prices filters into different areas of the economy. Furthermore, economists begin to outline the bigger picture when big shifts in commodities occur—sometimes encouraging further losses in confidence and further additional declines for the respective currency.
Moynihan continued: ‘The next year promises to be challenging for New Zealand dairy producers, however the longer-term outlook remains positive, with prices expected to return to more profitable levels for farmers into the 2015/16 season.’
However, there is hope for improvement. The latest fortnightly GlobalDairyTrade auction saw the average price of dairy commodities increase slightly. Though prices only rose by 1.4%, it’s a small pocket of hope for dairy farmers that were expecting further cuts. The auction before had seen prices drop by 7.3% to lows not seen since August 2009.
The Canadian Dollar (CAD) Commodity Currency and Crude Oil
Oil prices have tumbled quite significantly in recent months. Canada’s largest export is oil with approximately 75% of Canadian shipments going to the US, their largest oil export destination. Last week saw Bank of Canada (BOC) Governor Stephen Poloz warn that if oil prices don’t pick up, the Canadian economy could suffer harmful effects. The central banker suggested that at least a quarter of a percentage point could be taken off of economic growth next year. While that may seem infinitesimal, the effect could be quite damaging with forecasts for growth to reach between 2-2.5 % in 2015.
Bank of Canada Governor Poloz ‘Concerned’ about Effect of Falling Oil Prices
Poloz commented: ‘We would estimate that at this stage that effect, net, on Canada would be to take perhaps a quarter point off Canada’s GDP [Gross Domestic Product] growth for 2015 –which is sufficient for me to think about it and be concerned about it. A quarter-point matters a lot in that [moderate growth] context. It might cause a change in the terms of the balance in the price of housing.’
However, the price of oil rises when access to Middle-Eastern oil supplies is threatened by terrorism, global conflict or social unrest. University of California Executive Director for energy and sustainability Amy Myers commented: ‘I don’t think consumers are out of the woods. I think we could see very high gasoline prices again in the next couple of years if something went wrong in the Middle East, for example.’
Myers continued: ‘Part of the reason that Google and Intel and Microsoft and all these companies have come up with these fantastic energy efficient batteries, storage and off-grid energy solutions is because the utilities… couldn’t provide them with reliable electricity. So I think renewable energy, even though the oil industry doesn’t believe it, is going to continue to compete.’
Poloz has estimated that any drop in oil below 90 US Dollars per barrel will prove harmful for Canadian economic growth. Myers weighed in: ‘Because oil is geopolitical, you can never say that consumers don’t have to worry about it. My opinion is, barring a major catastrophe in the Middle East, oil will drop to $50 a barrel, and gasoline prices are going to get even lower than they are now.’
Lower oil prices allows higher consumer spending and can help fuel economic recoveries. However, as the ‘Loonie’ and oil prices are so intimately linked, the Canadian commodity currency is unlikely to rise whilst oil values are so low.
Commodity prices usually result in a lower currency. As demand for a product weakens, it threatens exports and prices. The Australian, New Zealand and Canadian Dollar all embody the major qualities of a commodity currency, with their value closely linked to their predominant export.
