FX WatchEl Niño and commodity FX

Group Economics

Macro & Financial Markets Research

Georgette Boele +31 20 6297789

Roy Teo +65 6597 8616

4 June 2015

The chance of an El Niño weather event is high, but it will likely be a weak to moderate one. If an El Niño shock were to occur,

some regions will experience deviations from their normal weather patterns. This can have material effects on their economy.

Policymakers are likely to respond should these effects endanger their policy targets. The central banks of Australia and New

Zealand are likely step up monetary policy easing and this will weigh on the Australian dollar and New Zealand dollar. The

South African rand is unlikely to be sold off aggressively because of a vigilant central bank. However, Latin American

currencies will probably benefit because of higher interest rates and stronger growth.

El Niño weather phenomenon attracting attention…

The possibility of an El Niño weather phenomenon (see box 1)

occurring this year has attracted attention. This is because if

an El Nino shock were to occur, the impact on some

economies and commodity prices (especially agricultural

prices) could be significant.

El Niño Summer

Blue = wet, orange = dry and red = warm

Source: NOAA

El Niño Winter

Blue = wet, orange = dry and red = warm

Source: NOAA

Box 1:

El Niño explained

El Niño is a natural phenomenon caused by unusually warm

ocean temperatures in the Equatorial Pacific, that leads to

significant deviations from normal weather patterns. In

particular, El Niño can lead to a disturbance in rainfall patterns.

The lead time between measured unusual water temperatures

and disturbed weather patterns can be as long as one year.

Among these consequences is increased rainfall across the

southern tier of the US and in Peru, which has caused

destructive flooding, and drought in the West Pacific,

sometimes associated with devastating bush fires in Australia.

Observations of conditions in the tropical Pacific are

considered essential for the prediction of short term (a few

months to 1 year) climate variations. El Niño can be seen in

measurements of the sea surface temperature

Source: National Oceanic and Atmospheric Administration (NOAA)

Chance of El Niño occurrence is high, but a weak to

moderate one…

According to US NOAA Climate Prediction Center there is an

approximately 90% chance that el Niño will continue through

Northern Hemisphere summer 2015, and a greater than 80%

chance it will last through the end of 2015. By early May 2015,

weak to moderate El Niño conditions were reflected by above-

average sea surface temperatures across the equatorial

Pacific.

What is the impact of El Niño shock on real GDP and

inflation?

According to an IMF Working Paper, Fair Weather or Foul?

The Macroeconomic Effects of El Niño, April 2015, an El Niño

event has a significant effect on real GDP growth for most

countries in the sample (the countries below including

Argentina, Malaysia, Philippines and Saudi Arabia). While

Australia, Chile, Indonesia, India, Japan, New Zealand and

South Africa face a short-lived fall in economic activity

following an El Niño weather shock, the US, Europe and China

eventually benefit from such a climatological change.

2 FX Watch - El Niño and commodity FX - 4 June 2015

El Niño shock on real GDP

In %

Source: IMF April 2015

In addition, most countries experience short-run inflationary

pressures following an El Niño episode (see graph below).

El Niño shock on inflation

In %

Source: IMF April 2015

What does this mean for our outlook of commodity

currencies?

If an el Niño shock were to occur and its effects are in line with

the above mentioned IMF study, what does this mean for our

outlook of commodity currencies? This can only be determined

by combining the impact on GDP and the impact on inflation,

because they will be crucial for setting monetary policy (see

graph below) and the direction in the currency.

More monetary policy easing in a number of countries…

It is likely that the central banks in Australia and New Zealand

will ease more aggressively this year and/or have a longer

easing cycle to support their economies in case of an el Niño

shock. Adverse weather effects will affect food and agricultural

output in both countries and weigh on growth. The impact on

the New Zealand economy will be more substantial. Therefore,

the central bank may ease more aggressively. The prospect of

a weaker economy and more monetary policy easing (because

of low inflation pressures) will add further pressure on the

Australian dollar and the New Zealand dollar in our view. As a

result, it is likely that they will fall further than currently is

reflected in our current currency forecasts.

El Niño shock on inflation and real GDP

In %

Source: IMF April 2015

…however the SARB will unlikely ease …

Despite weak economic growth in South Africa, inflationary

pressures persist. It is likely that the South African Reserve

Bank (SARB) will hike interest rates at their next meeting. In

the occurrence of an el Niño shock, the drop in economic

growth will unlikely result in rate cuts because inflationary

pressures remain because of upward pressure in power costs.

Therefore, the central bank will probably continue their current

vigilant stance. This will continue to have a negative effect on

economic growth.

During the Fed tapering dry-run, the rand belonged to the

group of fragile five currencies that weakened sharply when

financial markets upward adjusted Fed rate expectations. This

year, we expect another wave of US dollar strength based on

expectations of higher US rates and yields. However, we

expect the rand to be more resilient than in the past. Granted

the South African current account deficit remains substantial at

5% of GDP (see graph below). Therefore, the rand remains

vulnerable to changes in investor sentiment. However, the

current account deficit is on an improving trend. Moreover, a

small portion of debt is foreign denominated and foreign

reserves position are stable at comfortable levels. This will

increase the resilience of the rand. In addition, it is likely that a

vigilant central bank will gain market confidence despite weak

economic growth. Last but not least, the rand is massively

undervalued. So the occurrence of an El Niño shock wills

unlikely result in a change of our USD/ZAR forecasts.

…while other central banks could become more restrictive

Even though an El Niño shock will probably bring higher

economic growth in Brazil, Mexico, Chile (according to this IMF

study), it will also bring higher inflationary pressures. The

combination of higher growth and inflation, may push interest

rates in Brazil higher. However, monetary policy is already

-2.0

-1.0

0.0

1.0

2.0

ID SA NZ AU IN JP US CN KR BR EU CL CA SG MX TH

Impact After 4 quarters

-1.0

-0.5

0.0

0.5

1.0

1.5

NZ CA SG AU EU SA JP CN US CL KR TH IN ID BR MX

Impact After 4 quarters

-2.0

-1.0

0.0

1.0

2.0

ID SA NZ AU IN JP US CN KR BR EU CL CA SG MX TH

GDP after 4 quarters Inflation after 4 quarters

3 FX Watch - El Niño and commodity FX - 4 June 2015

very restrictive and we judge that most of the hiking cycle is

behind us.

For Mexico and Chile, a combination of higher growth and

higher inflation could trigger an earlier start of a hiking cycle. A

combination of higher growth and higher official rates should

be supportive for the Brazilian real, Chilean peso and Mexican

peso. However, they will unlikely outperform the US dollar as

we expect the US Federal Reserves to hike more aggressively

than currently is reflected in prices.

Our commodity currency forecasts

Source: ABN AMRO Group Economics

04-Jun Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016

AUD/USD 0.7745 0.78 0.73 0.72 0.70 0.68 0.67 0.66

NZD/USD 0.7151 0.73 0.69 0.68 0.66 0.65 0.64 0.64

USD/CAD 1.2443 1.23 1.27 1.30 1.31 1.33 1.34 1.35

USD/NOK 7.7199 7.50 8.25 8.00 7.62 7.38 6.82 6.52

USD/IDR 13,281 13,200 13,500 13,700 13,800 13,900 14,000 14,100

USD/RUB 54.87 53 52 50 48 47 46 45

USD/ZAR 12.33 12.00 12.20 12.20 12.20 12.20 12.20 12.20

USD/BRL 3.13 3.05 3.25 3.20 3.20 3.10 3.10 3.10

USD/MXN 15.53 15.25 15.50 15.50 15.25 15.25 15.00 15.00

USD/CLP 628 630 630 630 635 640 645 650

4 FX Watch - El Niño and commodity FX - 4 June 2015

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