Inescapable link between US Dollar and commodities

In the financial markets eco-system, the various asset classes are linked with each other. Inflation has been the underlying factor influencing the global economy in 2022 in the aftermath of Covid 19 with central banks around the world tightening their monetary policy to manage the slump in their currencies and limit the skyrocketing inflation rates. The hawkish nature of inflation has been challenging for emerging market economies along with the strengthening US dollar. History depicts that all previous emerging market fallouts were linked to the strengthening of the US dollar. This has attributed the World Bank to forecast just a 4.6% expansion for emerging economies this year as compared to the previous 6.3% forecast. Likewise, International Monetary Fund expects inflation to average 9.5% in emerging markets during the same period.


Appreciating Dollar Influence on Emerging Market Economies

Since the greenback is the invoicing currency of the world and holds the highest purchasing power, a strong US dollar depresses global trade growth. In effect, when the dollar strengthens, other currencies take a backlash and depreciate making the rest of the world poorer. This has a negative repercussion for emerging market economies due to the disruption in their supply chains and commodities demand. Likewise, the appreciating dollar is also more likely to affect inflationary upward pressure for emerging markets since they typically purchase their raw materials in the US currency.


Commodity Appreciation

An important headwind for emerging markets is the immediate rise in prices of commodities forecasted to remain for some time given the complex economic landscape. Higher oil prices, skyrocketing food prices and higher import prices due to depreciating currency values are some instantaneous effects on the emerging markets. When the demand for product rises, demand for materials also rises which increases the value of commodities. The commodities markets are greatly influenced by the demand and supply dynamics compared to other inflation protection assets.
The rise in the prices of commodities tends to negatively factor the emerging markets but other economies stand to benefit as a result. Commodities are a critical source of export and revenue for many emerging economies and more than half of the world’s poor reside in commodity-exporting countries. The dependence on commodities is particularly high for oil exporters such as Brazil, Mexico and Russia and on metal and agriculture-related exports from South Africa and Chile.


Risk Management

The changing value of a currency versus the US dollar can have a substantial effect. Whether a country is an importer or an exporter will dictate either an advantage or disadvantage outcome from currency movements. For example, China is the numero-uno participant in the global copper market. Therefore, the exchange rate between the renminbi and the US dollar plays a significant role in this trade.

In another example, the US is the largest producer and exporter of corn and its southern neighbour Mexico is the largest importer from the US. As an importer, Mexico is more exposed to the exchange rate risk between the US dollar and the Mexican peso. If the US dollar appreciates, Mexican importers are adversely affected as corn becomes more exclusive, but vice versa if the US dollar weakens.

Similarly, the currency of South Africa, the rand, is linked with the prices of precious metals with the economy labelled as a major exporter. Although their prices are often correlated i.e. higher metals prices can lead to a stronger currency, there is still the exchange rate risk between the South African rand and the US dollar since the metals are primarily denoted in US dollar.

Keeping the above risk factors in mind, commodity and derivative exchanges around the globe enable trading and risk management of commodities. Each market participant should analyse their risk exposure in the physical market and undertake a risk mitigation strategy to minimise losses that may arise in the future if the market turns against them.


Conclusion

The objective of this article was to showcase the impact of the US dollar on the commodities market particularly for exporters and importers. When the US dollar is strong compared to other currencies, it will continue to hold the purchasing power and make it more expensive for emerging economies to engage in international trade. As depicted earlier, high inflation will also add to the struggle for emerging markets with central banks turning to tighter monetary policies to counter the rise in prices of commodities. As for inflation, it will continue to remain in the limelight for the ensuing days.

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Vivek Risal

Vivek Risal is associated with Mercantile Exchange Nepal Limited in the capacity of Manager in Research and Development Department. He can be contacted at r&[email protected]

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