Commodity markets across the board have bounced off their lowest prices and have been rising in the first two months of 2016. Abating fears of ever lower prices in commodity markets might signal that the time for a rebound in emerging market currencies has arrived.
The countries most tied to commodities have paid a high price and many now offer very attractive interest rates to compensate for the considerable risks – political and economic.During 2015, many commodity producers, from the energy sector to mining, went through periods of denial about low prices to accepting the view that relatively low commodity prices might last for years. They then went on to restructure debt, sell assets, and generally get their balance sheets in order to match the reduced expectations of revenue to future expenses.
The corporate restructuring phase is still continuing. However, we would argue that the most difficult decisions have been made. During the stressful period of restructuring, commodity prices tend to be pushed lower – below likely long-term ranges – in part because of the forced sales of assets involved in the corporate restructuring.
Based on this view of corporate restructuring in the commodity sector, commodity markets are possibly entering a new phase in 2016. The period of fear of ever lower commodity prices may be over, replaced by volatile markets seeking a trading range that matches the reality of a slower growing world.
Emerging market currencies have been beaten down, more or less since former Federal Reserve (Fed) Chairman Ben Bernanke started talking about ‘tapering’ quantitative easing (QE) back in May 2013. Our view has always been that a removal of emergency monetary policies in the U.S. was not the real problem for emerging market currencies. Instead, the problem has been the lack of demand for exports, and especially commodity exports on which many emerging market countries depend. And even if an emerging market country is not tied to commodity production, its neighbors and trading partners often are, leading to economic weakness across the sector. We would also note, in support of this view, that countries without substantial commodity resources, such as India, saw their currencies depreciate less than others during the period of the emerging market currency sell-off.
In summary, our interpretation is that the deprecation “contagion” involving emerging market currencies was driven primarily by a reaction to fears of ever lower commodity prices – meaning lower economic growth – which is often accompanied by rising political risks. If this view is accepted, then a shift in commodity market patterns – from fears of ever lower prices to finding a trading range that is realistic for a slow growing world – is very good news for emerging market countries.
The countries most tied to commodities have paid a high price and many now offer very attractive interest rates to compensate for the considerable risks – political and economic.
There are two other assumptions that are critical for this interpretation of commodity and emerging market currency markets. First, while the U.S. jobs market is healthy, wages are not rising much yet, and inflation pressure is minimal. In this environment, a data-dependent Fed is probably going to delay any further rate rises; possibly raising rates only once in 2016 in the September-December period. The Fed raised rates by 0.25% in December 2015 for the first time in nearly a decade. Second, China appears to be able to avoid a hard landing. Its growth deceleration is still in progress and is likely to continue into the next decade. Nevertheless, the Chinese Government has provided considerably more stimulus in the form of new loans to the economy that appears to be working to prevent a hard landing, even if growth slows further. Avoiding a hard landing, though, does not mean the Chinese yuan (RMB) will not continue to depreciate – even as emerging market currencies potentially rebound from their lows.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Bluford “Blu” Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. With more than 35 years of experience in the financial services industry and concentrations in central banking, investment research, and portfolio management, Blu serves as CME Group’s spokesperson on global economic conditions.
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