Commodity prices are the more tactical risk

Kamakshya Trivedi, Research Analyst at Goldman Sachs, explains that setting aside their more constructive long-term view, on a tactical basis some consolidation or even a modest pull-back would not be unusual after such sharp moves. But we think lower commodity prices are more likely to be the catalyst for such a pullback rather than the rates backdrop.

Key Quotes

“A key takeaway from the past month is the speed with which FOMC speakers were able to raise the probability of a hike on the Ides of March from below 30% to nearly 100%. And the fact that markets absorbed it in a relatively untroubled fashion suggests that, while the odds of another hike in June are higher, the Fed will not need to rush into signalling it strongly until later in the spring – with more time to see if the hard data are indeed moving to the stronger path that the survey data have been pointing to.”

“We do expect long-end rates to continue to move gradually higher, and those tend to be more impactful than front-end rates for EM FX. But, as our rate strategists have argued, a much sharper steepening beyond forwards is likely to require a more convincing pick-up in inﬂation expectations in Europe (and Japan) – which is likely to be limited until the outcome of the French election is clearer.”

“So the more near-term risk to EM FX (including our stronger MXN forecast) may come from the recent weakness in oil and the commodity complex. External balances have improved across the EM complex since 2012, many of our ‘goodcarry’ EM FX candidates – for example RUB, BRL, COP, ZAR – are signiﬁcant commodity exporters and would be negatively affected if commodity prices were to keep sliding. That is not the baseline expectation of our commodity team, but it is the key tactical risk to constructive EM views in the near term.”

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