Oil price impact on currencies
by Simon Derrick
Many supply factors have helped in the sharp declines in oil prices since the summer, most obviously Opec’s drive to maintain market share. Yet there is no escaping the fact that the decline in oil prices since last summer has coincided with a rally in the dollar.
The potential link between the two is simple enough. If money was flowing back into the dollar as the Federal Reserve entered the final stages of winding up the programme of quantitative easing, then it made sense that assets that had previously benefited from outflows from the dollar (such as oil during the second half of 2007 and the early part of 2008) were now finding themselves under pressure. There is little to suggest that the Federal Open Market Committee will be swayed from its course in 2015, and Opec appears committed to keeping the taps on as it squeezes out higher cost producers. So the question is whether this trend will continue and, if so, how likely it is to play out in the currency markets.
One starting point for such a discussion is the US Energy Information Administration’s list of top net exporters and importers of oil in 2012. From the foreign exchange market’s perspective, probably the most interesting of the net exporters (because their currencies are free floating) are Russia, Norway and Canada. The top net importers were (in descending order) the euro area, the US, China, Japan, India, South Korea, Singapore, Taiwan, Turkey and Indonesia.
The opening weeks of 2015 saw currencies of a number of key oil importers significantly outperforming the rest of the pack, while at the other end of the spectrum the rouble came under new pressure. With, on the one hand, Fed officials continuing to hint at an initial rate hike this summer and, on the other, no sign that Opec members are preparing to turn the taps off, it could be argued that the downward pressure on oil prices should remain in place for some time. However, there is a complicating factor. This is that while the Federal Reserve might be preparing to tighten monetary policy in 2015, many other major central banks (including the European Central Bank and the Swiss National Bank) are rushing to ease monetary policy as fast as they possibly can. Looking back over the past 15 years at the performance of Brent crude prices it is easy to make a link between the major moves and shifts in US monetary policy. The start of the 2001- 08 rally, for example, came after 11 months of aggressive easing by the FOMC, while latter stages of the move (between August 2007 and June 2008 ) were fueled by a rapid series of rate cuts from the Fed in the face of a slowing housing market.
Equally, between the end of November 2008 (when the US first introduced QE) and summer 2014 (as the FOMC came close to ending its asset purchase programme) Brent crude in dollar terms rose 137%.
It is worth noting that between March 2001 (when the Bank of Japan introduced QE) and March 2006 (when the policy was lifted) Brent crude rose by 136% in yen terms. Similarly, it can be argued that the post-2008 rally was not just fuelled by QE from the Fed but by a similarly aggressive policy from the Bank of England. In short, while there seems to be a fairly direct link between ultra-easy monetary policy and demand for a hard asset such as oil, it is not just US monetary policy that matters when considering oil price moves.
Offsetting the prospect of a US rate hike later this year is the promise from ECB President Mario Draghi that the ECB’s expanded asset purchase programme will remain in place until at least September next year. This has had a powerful effect on, seen in the strong performance of currencies such as the peso, rupee, rand and dollar this year. Given this, another question is whether there is any evidence emerging of better price dynamics for oil. For the moment the jury remains out. However, it is interesting to note that since 14 January (the day before the Swiss National Bank abandoned its exchange rate policy and it became clear the ECB was preparing to carry out full-scale QE), Brent crude oil prices have stabilised.
Under pressure Moreover, while the rouble and Canadian dollar have remained under pressure (not least due to some aggressive monetary policy moves in Russia and Canada), it is noticeable that the pace of losses for the Norwegian krone has slowed significantly. This is not sufficient evidence to start building a case for a sustained recovery in oil prices and associated currencies. However, there is a clear correlation between oil price movements and fluctuations of currencies from countries which face corresponding economic repercussions. Currency operators should be prepared for further evidence of these relationships in coming months.
■ Simon Derrick is Chief Currency Strategist at BNY Mellon. The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This is not a solicitation, does not constitute investment advice, or any other business or legal advice, and it should not be relied upon as such.