Oil-linked currencies slightly expensive given the current oil price level – SocGen

Research Team at Societe Generale, suggests that the past few weeks have been quite heavy in terms of central bank actions, particularly by the BoE and BoJ.

Key Quotes

“Yet volatilities in the equity, FX and fixed-income spaces continue to remain at multi-year lows, leading us to wonder if markets aren’t being too complacent. Taking a closer look, we see some opportunities, in particular in the Commo/FX space.

All oil-linked currencies (CAD, BRL, NOK and RUB), except for the MXN, are now overvalued given the current level of the oil price and the dollar index. We observe that the strong relationship between oil and oil-linked currencies remains significant, allowing us to gauge the value of the currencies through this approach. Our model indicates that CAD, BRL, NOK and RUB are now slightly expensive. In effect, despite the slide in oil price in July, oil-linked currencies have failed to reflect the recent oil price weakness. Despite this, we retain our positive stance on the overall oil-linked currencies space, as we have a constructive view on the outlook for oil prices over the medium term.

As explained by our oil analyst Mike Wittner the fading impact of crude supply disruptions, mainly in Canada and Nigeria, as well as continued high inventories, has exerted downward pressure on prices. Going forward, we maintain our constructive stance on oil for next year and our oil analyst forecasts Brent at $48/b for 3Q16 and $50/b for 4Q16. The rebalancing process between supply and demand is still ongoing and we expect a “broadly-balanced” market by the next four quarters, with significant stock draws in 2H17.

We retain our positive stance on oil-linked currencies on a medium-term outlook, despite the recent richness which may provide some short-term opportunities. Given our constructive outlook on oil and the strong depreciation of commodity-linked currencies since July 2014, we believe that there is more upside ahead. In the current search-for-yield environment, we continue to prefer high yielders like the Brazilian real and the Russian rouble, both additionally supported by a hawkish monetary policy stance. We are waiting for better entry points for the Mexican peso as its current story is strongly linked to the US elections.”