China’s zero-Covid policy and broader economic circumstances could be weighing on currencies that should be reaping the benefits of higher commodity prices, strategists at BMO Capital Markets have suggested.

Although commodity prices have soared so far in 2022, with Brent crude on Wednesday notching its highest price since October 2014, commodity-based currencies such as the Norwegian krone and Australian, New Zealand and Canadian dollars have been relatively subdued.

As of Friday morning in Europe, the Aussie dollar was down 0.9% and the kiwi by 1.45% against the greenback year-to-date. The Canadian dollar was also down 0.9% year-to-date, while the U.S. dollar had gained 0.55% against the Norwegian krone.

“What we would typically expect to see is the New Zealand dollar rallying alongside agricultural commodity prices and Aussie rallying alongside base metals, but thus far this year, Aussie and Kiwi are both down — get this — against the euro and the yen,” Greg Anderson, BMO’s global head of FX strategy, said in a podcast last week.

Anderson noted that the central banks in these commodity-driven economies have been less hawkish than the U.S. Federal Reserve so far this year, but suggested this only provides a partial explanation for this divergence between commodity prices and commodity currencies.

He highlighted that the two-year swap rates, a type of derivative that’s a key barometer for currency strategists, for Aussie and kiwi dollars had underperformed the U.S. dollar, which would lend weight to the hypothesis that central bank policy divergence is a factor.

However, the Canadian swap rate has performed very similarly to the U.S., so this does not explain why CAD has not rallied alongside oil, Anderson argued, adding that a further mystery is how the AUD and NZD are losing ground against the euro and the yen, when the swap rates for both are roughly flat.

Chinese demand

European Head of FX Strategy Stephen Gallo suggested that ripple effects from China could be feeding into the performance of developed market commodity-based currencies.

“We know China is implementing its zero-Covid strategy. That has implications for both supply and demand, but it could conceivably be eating into China’s demand for certain raw materials,” Gallo said.

“We know there were power cuts and factory closures late last year, the property market is clearly in a slowdown phase, and we also know policymakers are not adding huge amounts of fiscal and monetary stimulus, even though they’ve adopted an easing bias.”

Gallo noted that international trade data out of China shows evidence of slower nominal growth rates of certain commodity imports, while import growth has been more subdued than export growth.

“Is that growth backdrop in China transmitting through to commodity-based currencies? Yep, possibly it is. Might China’s economic backdrop contribute to a deceleration in global inflation pressures later this year? Possibly, but we don’t know for sure,” he added.

Shifting sands

Over the medium term, Gallo suggested that the Chinese government’s Made in China 2025 initiative, which aims to reduce China’s reliance on foreign tech imports and invest heavily in domestic innovation, could permanently alter the way that Chinese demand influences global currencies.

However, it is difficult to pinpoint the extent to which the implementation of that policy is factored into present price fluctuations, he noted.

“Perhaps the Chinese economic backdrop is only having a partial effect on commodity prices because we are seeing excess demand in other parts of the world helped by very loose monetary policy and, more importantly, very loose fiscal policy,” Gallo said.

“Maybe there is also an element of the green transition embedded in energy prices and base metals too. Perhaps the equilibrium prices of certain commodities are simply changing.”

Anderson suggested that the equilibrium pricing in many commodities will become “semi-permanently higher” through the green transition’s shift in demand, particularly in the likes of base metals, which he said will benefit metals-reliant currencies like the South African rand and Chilean peso.

‘Buy the dip’

In terms of current trades, Anderson recommended investors look to “buy the dip” in the AUD-JPY currency pair.

“From both a commodity price and an interest rate differential perspective, the pair should have rallied, but it hasn’t. I would still be looking to position for a move back up to 86 or so by mid-year in Aussie-yen,” he said.

Meanwhile Gallo suggested backing the euro to move lower against the Canadian dollar, a trade he said was supported by three key factors.

“Firstly, you have got higher oil prices, which compound the impact of the increase in natural gas prices. Secondly, net trade. The euro area recorded its first merchandise trade deficit with the rest of the world last November in almost a decade,” he said.

The third support beam is the expectation that the divergence in monetary policy between the extra-dovish European Central Bank and slightly more hawkish Bank of Canada could have further to run.

“I don’t think there’s a huge amount, given what’s already priced in for the Bank of Canada, but I think there’s still a bit more left. I think euro-CAD can take a stab at the high 1.30s before the cycle ends,” he added.