Currencies Get Real

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

Rates continue to move higher around the world as central banks do their best to combat inflation. 

As investors, our best course of action is to position ourselves in those areas that benefit most from rising rates.

Commodities and cyclical stocks immediately come to mind. But there are also specific currencies that tend to excel in rising rate environments.

Today, we'll discuss a handful of emerging-market currencies with heavy commodity exposure. 

We’ve been waiting on these currencies to catch higher and confirm the price action in commodities since last year… and it looks like it’s finally happening.

Let’s dive in.

First up is an overlay chart of the US 10-year yield and our equal-weight basket of EM commodity currencies:

As you can see, these currencies trend in the same direction as interest rates over the long run. 

Our EM Commodity Currency Index includes the Mexican peso, the Brazilian real, the Chilean peso, and the South African rand.

It’s no surprise that these currencies follow yields given these countries’ economic dependence on natural resources. Just like commodities, these currencies are part of the global growth and inflation theme.

So, with the 10-year yield catching higher, we want to err on the side of upside resolutions for many of these currencies. And that’s exactly what we’re beginning to see.

Last week, the Brazilian real broke to its highest level since the summer of 2020:

After consolidating for almost two years, the real is resolving higher from a large rounding bottom pattern.

As long as it’s above the breakout level near 0.2050 we like it long with an initial target near 0.2300. With that said, the real is off limits if it falls back into its prior range.

The Mexican peso is another EM commodity-centric currency poised to gain against the US dollar:

The USD/MXN cross dropped to fresh five-month lows last week after violating its year-to-date pivot lows. It looks like we’re about to get a fresh leg to the downside.

Last month’s lows around 20.15 is our line in the sand. If it’s below there we want to be short with a downside target near the 2020 lows around 18.50.

The Brazilian real and the Mexican peso are two great examples of currencies that are gaining against an otherwise strong US dollar.

We want to use these pairs to express a bullish thesis on commodity currencies as the intermarket backdrop is supportive of higher prices.

Not only is this an interest rate story. Seeing these currencies break out also supports the price action in commodities and suggests this bull market has staying power.

If this strength ever broadens out to the rest of the currency market and we see sustained weakness in the US dollar, it will be a catalyst for even higher commodity prices.

While it hasn’t happened yet, we’re definitely headed in that direction.

Thanks for reading.

As always, let us know what you think.

And be sure to download this week’s Currency Report!