Idea of the Day Why commodity FX may not play catch up with Brent

We have spoken in detail about the push higher in the Brent crude price and the widening spread with WTI crude. Is it driven by the Open production cut, but surely that must be priced in by now? Is it the recent anti-corruption purge in Saudi Arabia lending Brent a safe haven status?

Regardless of what is driving Brent, it continues to move higher. This morning it broke above the $64 per bbl mark and although it has fallen back slightly, the price of Brent is still up more than 6% this month. So, is it time for commodity FX, which has been lagging this rise in crude oil to play catch up?

As you can see in chart 1 below, which shows Brent and the key commodity FX pairs normalised to show how they move together, the Brent crude price underperformed the commodity FX space until July, however, it really started to pick up the pace in October. Below we lay out our view why the commodity FX space may not follow in Brent’s footsteps.

• Brent started to outpace the commodity FX space prior to the Opec production cut extension news and before the Saudi Arabian anti-corruption drive.
• This suggests that the Brent move could also be driven by technical forces.
• Brent has broken above the 38.2% retracement level of the 2014 peak to 2016 low, which is a bullish development and could open the way to $71.00, the 50% retracement of that long term downtrend (see chart 2).
• Correlation analysis suggests that commodity currencies including the NOK, AUD and the CAD don’t have a fantastic correlation with the price of Brent over the long and short term.
• Brent and NOK/USD have a 30% correlation YTD, however, this has increased to 40% so far this month, which is still insignificant.  
• The most significant correlation is the Canadian dollar, which has a 64% positive correlation so far this month. However, correlations can be deceiving, as the correlation in October was negligible. The uptrend in the CAD and Brent in recent days is most likely coincidence, we believe that the CAD’s resurgence was more a function of good payrolls data in Canada and thus could be short-lived.

Overall, commodity FX is driven by different factors compared to Brent, which is why, even though we believe that Brent may continue to move higher, the commodity FX space may not follow suit. Commodity FX may only rise if we see the dollar stumble, and that may only happen if we see the Fed take a dovish turn or if US tax reform starts to stall in the coming months.

Chart 1:

Source: City Index and Bloomberg

Chart 2:

Source: City Index and Bloomberg