Is it safe to buy commodity currencies after plummeting from 2022 highs?

Today’s inflation report released in the United States revealed that we may have seen the peak in inflation in April. Inflation is why investors pile into commodities, as they act as a hedge against the rise in the prices of goods and services.

In response to the COVID-19 pandemic, governments and central banks worldwide eased fiscal and financial conditions. As such, inflation advanced, and so did commodity prices.

Supply chain bottlenecks also fueled inflation. They still exist, and inflation kept rising in April, albeit at a slower pace than the same period last year.

So will investors buy the recent drop in commodity currencies? Or has the trend only started?

Commodity currencies remain under pressure as inflation may have peaked

While the stock market topped in late 2022, commodity currencies continue to rally. Take the AUD/USD exchange rate, for instance.

It opened the year at around 0.72, jumped to 0.80, only to give all its gains and drop below 0.70 recently.

One may argue that the drop was inevitable. After all, the Federal Reserve hiked the funds rate by 75bp in the meantime.

However, a few things are worth mentioning.

First, the AUD/USD peaked in 2022 right after the Reserve Bank of Australia surprised the markets with a bigger than expected increase in rates.

Second, the Fed delivered the first rate hike of the current cycle before the Reserve Bank of Australia did.

Finally, the subsequent rate hikes from the Fed were priced in. Hence, one may argue that the rise and fall in commodity currencies have nothing to do with the rate hikes but with how inflation evolves over time.

After forming a head and shoulders pattern, the AUD/USD smoothly headed towards the pattern’s measured move. It now dropped below the pivotal 0.70, but finds buyers below.

Similar price action is seen on the Canadian or New Zealand dollar pairs. Can it be that the potential peak in inflation affects commodity currencies?

If that is the case, it is hard to believe that there is much more room to the downside. But unless the AUD/USD comes back above its 2022 opening levels (i.e., 0.7200), the pressure remains for new lower lows in the months ahead as inflation cools off.