Does Export Composition Determine the Forecasting Power of Exchange Rates on Commodity Prices?

Abstract

It is important for both inflation control and production planning to have reliable predictions on primary commodity prices. Previous studies show that “commodity currencies”, currencies of countries with large primary commodity export shares, carry information about future primary commodity prices. In this paper we study if this relationship also applies to “non-commodity currencies”, currencies of countries with a small share of primary commodity export. We perform both in-sample and out-of-sample analysis of exchange rates’ forecasting power on country-specific commodity price indices and world commodity price indices. The results show that exchange rates possess information about future primary commodity prices, but the primary commodity prices do not possess information about future exchange rates, which is consistent with previous findings in the literature. They also show that non-commodity currencies possess forecasting power, hence this relationship is not unique for commodity currencies.