Majors vs commodity currenciesKnow what really drives the currency you trade.
Majors move mainly on their economy and central bank. Commodity currencies move on the price of what their country exports. Knowing which group a currency belongs to tells you what to watch.
Majors and commodity currencies
The currency market is the most liquid market in the world, with more than $5 trillion traded every day. For easier understanding, it can be split into 2 groups. Majors are the most traded currencies, such as the euro, the yen, the British pound and the Swiss franc, each traded against the US dollar. Commodity currencies come from countries where exports of raw materials, such as oil or metals, make up a big part of the economy.
The 2 groups react to different news. A major can weaken on a dovish central bank while commodities rally, and a commodity currency can drop on an oil slump even when its central bank sounds firm. So the first step with any currency is to know which group it belongs to.
Economy and central bank
- Euro, yen, pound, franc
- Growth lifts rate expectations
- Rate cuts or printing weaken
- Politics: the Brexit vote
- Yen and franc: safe havens
What the country exports
- Canada, Norway, Russia: oil
- Australia, New Zealand, Brazil: broad commodities
- Trading partners such as China
- A weaker US dollar
Majors: the economy and the central bank
The value of a major currency depends mostly on 2 things: how its economy is doing and what its central bank does. When output grows, the market expects higher interest rates, and the currency gains. When the central bank cuts rates or prints money, or the economy weakens, it loses value. A rising US dollar also pulls the majors down against it.
Politics matters too, because political risks can quickly turn into economic ones. After the British vote to leave the EU in 2016, the pound lost a lot of ground.
The yen and the franc: safe havens
The Japanese yen and the Swiss franc have an extra quality: they are seen as safe havens. When stock markets fall and investors get nervous, money flows into them, often at the same time as into government bonds, and they gain value. During the Greek debt crisis, this was one of the reasons the Swiss franc rose sharply.
When stocks rise and investors relax, money tends to leave them again. So for these 2 currencies, the mood of the stock market can matter as much as the central bank, and the risk sentiment indicator in Prime Terminal is worth a look before you trade them.
Commodity currencies: follow what the country sells
Commodity currencies come from countries where raw material exports are a big share of GDP, so a rise or fall in commodity prices hits the economy and the currency directly. Canada is the clearest case. It is a big energy exporter, so the Canadian dollar rises when oil rises and falls when oil falls, and USD/CAD moves almost in step with the oil price, only upside down. The Russian ruble and the Norwegian krone behave in a similar way.
Other commodity currencies follow a broader basket. Australia, New Zealand and Brazil export many different raw materials, so their currencies react to commodity prices in general rather than to oil alone.
Trading partners matter as well. China is one of the world’s biggest buyers of raw materials and an important trading partner for New Zealand. When China’s economy slows, its demand falls and the New Zealand dollar feels it. Central banks still matter for these currencies, but less than commodity prices do.
Before you trade a commodity currency
Open an oil chart next to USD/CAD. If oil is climbing strongly, a long USD/CAD trade fights the Canadian dollar’s main driver and needs a very good reason. A rate decision by the Bank of Canada can be swamped by a big move in crude.
Weak Chinese data means less demand for raw materials, and the New Zealand dollar is among the currencies that feel it. Check the China numbers in the Economic Calendar before you trade it.
Mistakes to avoid
- Selling the yen or the franc in a market panic because their central banks are dovish. Safe-haven buying can overpower the policy for a while.
- Forgetting that every pair has 2 sides. In AUD/JPY a commodity currency meets a safe haven, so a nervous day in the markets can hit the pair from both ends.
In short
- Majors such as the euro, the yen, the pound and the franc move mainly on growth, their central bank and politics.
- The yen and the franc are safe havens: they tend to gain when stock markets fall and fear rises.
- Commodity currencies follow what their country exports and who buys it: oil for the Canadian dollar, broad commodities for the Australian and New Zealand dollar, and China for New Zealand.
Key terms
- Commodity currency
- A currency of a country that exports a lot of raw materials, like AUD, CAD or NZD. It often moves with commodity prices and global growth.
- Safe haven
- An asset investors buy when they are scared, such as the Japanese yen, the Swiss franc, gold or US government bonds.
- Central bank
- The institution that sets a country’s key interest rate and controls the money supply, like the Fed, the ECB or the Bank of England.
- Currency pair
- Two currencies quoted against each other, like EUR/USD. Buying the pair means buying the first currency and selling the second.