Will the Fed lift commodity currencies?

Inside the mind of the Fed

All eyes will be on the U.S. Federal Reserve's meeting this week but it will be especially crucial for battered commodity currencies hoping for respite from a weaker greenback.

The Fed isn't likely to move on interest rates at Wednesday's meeting, but markets are hotly awaiting the post-meeting comments for hints on whether the central bank will raise rates in September. Should that happen, the could see another burst of strength and put further pressure on commodity-exporting nations like Australia, Canada, New Zealand, Brazil and Indonesia, who are hoping that Fed Chair Janet Yellen will sound a cautious tone and pause the sell-off in those currencies.

Australian exports are dependent on iron ore, New Zealand relies on dairy products and energy makes up the bulk of Canadian, Brazilian and Indonesian exports. Therefore, a sharp tumble in prices of energy, gold, dairy and metals combined with a stronger dollar, a weakening Chinese economy and bets on looser monetary policy - excluding Brazil where rates remain high - have seen commodity bears out in full force in recent weeks.

Both the Australian and traded at six-year lows on Monday, while Friday saw the Canadian dollar and the Brazilian real tumble to 2004 and 2003 troughs respectively. Meanwhile, Indonesia's rupiah hit a fresh seventeen-year low on Monday - the seventh time in two months.

The case for caution


IG's market strategist Evan Lucas believes Wednesday's meeting could be a boon for the crumbling commodity sector.

"The Fed policy statement release may actually halt the USD bulls," he said in a morning note on Monday.

"Expectations are low for any major divergence from current language or action. The FOMC may even be a little more cautious about the current market and economic conditions. This would see a quick unwind in oversold markets: Oil and industrial metals would likely rise and a likely drop in the USD would transpire."

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Indeed, markets do seem to be skeptical on the chances of a September rate hike, bolstering the chances of dollar weakness.

"The market is still refusing to price in Fed hikes. 85 percent of economists surveyed see Fed lift off in September, but the market is only pricing in a 10-basis-point move in September at 45 percent," Lucas continued.

AMP Capital echoed that view. "The U.S. money market appears to be attaching a 25 percent chance to a September move," noted Shane Oliver, head of investment strategy and chief economist.

Hawkishness may prevail

To be sure, the majority of strategists do expect Yellen to guide the market firmly towards the possibility of a September hike on Wednesday.

"Hawkishness from the Fed would help to reinvigorate the dollar," noted Kathy Lien, managing director of BK Asset Management. "So not only are we looking for the dollar to come back into focus but we are also looking for the rally to return."

"Some investors are worried because retail sales declined, job growth slowed and average hourly earnings stagnated in the month of June but all three saw gains in the third quarter and as such the Fed is likely to downplay the weakness and focus on the improvements in the housing market and the drop in the unemployment rate," she explained.

Societe Generale agreed, stating that its central scenario was for a hike in September with a second hike unlikely until early 2016. "That should be enough to dampen pressure on the dollar," the bank said in a recent note, adding that a 5 percent appreciation over the next three quarters is possible.

The Royal Bank of Scotland (RBS) is also pricing in a stronger greenback over the next few months. Taking the commodity price pressure and a slowing China into consideration, "all roads are leading to weaker commodity currencies at the moment," RBS said in a Monday note.