Follow Us

Oil and Forex

Higher oil prices have a negative impact on consumer spending. The obvious reason is that, higher oil prices results in higher cost of production of the majority of consumer goods.Then again, higher oil prices make the individual consumer spend a bit more on their gas and fuel for heating their homes. This means that higher oil prices invariably results in an economic downturn in most countries in the world.

The opposite situation happened in 90s when the oil prices averaged $20 or so which eventfully leaded to the collapse of the Soviet Union. Note that at that time US President Reagan was also actively jeopardizing the Soviet Union's ability to sell natural gas to Europe simultaneously actively working to maintain gas prices low, which kept the price of Soviet oil low and further starved the Soviet Union of foreign capital.

This is, of course, an extreme example but what is clear that the low oil prices have a negative impact on the economies of oil producing countries such as Nigeria, Mexico or Venezuela all of which are oil producing countries but nevertheless developing countries too. These countries have large external debt which needs to be serviced from the oil revenues. Therefore low oil prices is detrimental to their economic survival.

On the other hand developing countries such as Thailand, Malaysia, Indonesia and many other non-oil producing developing countries in Asia and Africa greatly benefit from the lower oil prices. That is because they can then make substantial forex savings on importing oil at a lesser cost and at the same time access capital from developed countries at lesser interest rates.

Now that you know the effect of high and low oil price on the economies of countries, you might be perhaps wondering why you should be worrying of oil especially in forex trading. After all you are not buying and selling oil in forex trading (although some brokers offer this type of trading as well).

However, it is the fact of the matter that the major currency pairs follow the rise and fall of oil. In other words, the price of oil is a leading indicator of currency price fluctuations and this dependence is not going to vanish in the near future.
Why does this happen? Reasonably developed countries producing crude oil benefit from high oil prices as tremendous surplus funds are generated for their use. On the contrary oil importing countries benefit from lower oil prices and loose that advantage as oil prices go up.

We all know that as the economy of the country gets strong, its currency naturally becomes dominant in the forex market. As opposed to that as the economic situation weakens the currency weakens as well. This is the role between oil and relationship between oil and currency prices.

Another important point is that, if the dollar were to appreciate then the oil prices in real terms rise in relation to the sterling and yen. Therefore low oil prices alone would not translate into income gains for European and Japanese consumers if the dollar were to appreciate.

Looking at recent oil prices it seems that oil is definitely in an aggressive price mode. There doesn’t seem to be a reversal of the price trends in the near future

Although there are several intertwined issues to be considered such as the political situations, natural disasters in general the currency of nations that produce and export oil will rise in value and the currencies of nations that import oil and depend on it for their exports will drop in relative value.

Profitable forex trades may involve a country that exports oil against a country that depends on oil imports.

For instance, consider CADJPY. Sometimes traders dealing this pair land up with the most profitable trades because Canada produces oil in abundance and the mechanics of this oil production gives rise to a buoyant Canadian dollar.

In other words Canada is the most important supplier of oil to the US and is fast gaining momentum as the largest supplier of oil to China also. This makes the Canadian dollar attractive from a trading perspective when the oil prices rise.

On the contrary, Japan imports almost all its oil which makes their economy sensitive to oil price fluctuations.

What this means is that the price of Japanese exports increases along with the oil price which leads to a weakening of their position in the forex markets. So when the price of oil increases you could well expect a decrease in the value of yen.

Finally if you look at the oil prices from an economic and historical perspective, you will be better prepared to test its relevance to currency prices. That is something which you gain in experience from actually trading in the forex markets.