How Oil Prices Influence in Forex?

Oil is a key component in the economies of both developed and emerging market nations. Variations in oil prices, however, may bring particularly strong effects in emerging market economies.

Success in the foreign exchange market can only be attained if one is to take into consideration all the forces that influence the behavior of the currency market. As such, every forex traders should take heed of oil and its immense influence over the foreign exchange market as a whole. The price of oil has always been a vital gauge of the world's economy not only because the modern world is heavily reliant upon petroleum but also because the level of oil prices affect the performance of major financial markets such as the forex.

The connection between the price of oil and the economy of many countries is based on a couple of simple facts:

  • Countries with healthy supplies of crude oil benefit economy-wise from higher oil prices.

  • Countries who depend on imports for their energy needs benefit from lower oil prices and lose when oil prices rise.

  • When the economy of a country is strong, its currency is also strong in the forex market.

  • When the economy in a country takes a downturn, its currency loses value in the currency exchange rate.

What will this mean for the currency trading market?

In the currency market, exchange rates are often predicated on the health of a country's economy. If the economy is robust and growing, the exchange rates for their currency reflect that in higher value. If the economy is faltering, the exchange rate for their currency against most other currencies also stumbles. Knowing that, the following makes sense:

  • The currency of countries that produce and export oil will rise in value.

  • The currency of countries that import most of their oil and depend on it for their exports will drop in relative value.

  • The most profitable trades will involve a country that exports oil vs. a country that depends on oil.

VULNERABILITY IN EMERGING MARKETS

Countries that can be especially affected by oil price variations include some of the major emerging market nations that serve as the driving economic motors of the regions where they are located. Among these are the so-called “BRICS,” including

  • Brazil

  • Russia

  • India

  • China

  • South Africa.

BRAZIL

Traditionally, Brazil was a net importer of oil, and its domestic prices and economic activity could be strongly affected by international oil price fluctuations. a steep decline in oil prices can have a negative impact on Brazil’s export capacity and contribute to a generally weaker level for the country’s currency, the Brazilian real.

RUSSIA

Russia has long been considered a large-scale oil producer, with heavy domestic production dating to the early 20th century. Russia’s trade balance is also heavily dependent on oil, which represents more than 60% of the country’s total exports. Considering this dependence, the Russian ruble is likely to remain weak when oil prices are low.

INDIA

India is the fourth-largest consumer of oil and a heavy consumer of imported oil. As such, the country stands to benefit whenever the global price of oil declines. In particular, price declines ease local inflation and help diminish the current account deficit. These factors can be helpful in strengthening the country’s currency, the rupee.

CHINA

China is one of the world’s largest net importers of oil, and thus stands to benefit from lower global crude prices. Crude oil accounts for more than 10% of the country’s total imports, and low prices help boost the country’s current account surplus and growth of the GDP. These factors would normally help contribute to the strength of the Chinese currency, the yuan.

SOUTH AFRICA

South Africa is a net importer of oil, so the country can benefit when oil prices decline. A lower cost of fuel can help lower transportation costs, bringing a beneficial impact on food and consumer goods prices, and helping cut inflation. Oil accounts for more than 15% of South Africa’s total imports, and thus any decline in oil prices can be expected to have a positive influence on the strength of the country’s currency, the rand.

As already explained, strong economies have strong currencies, and most of these economies are strong because of oil. This means that the economy will either strengthen or weaken depending on what is happening to the oil price. Since currency trading is done by using currency pairs, oil prices will affect some currency pairs more than others. For example: Canada has become a big producer over the years while Japan is a significant importer of crude. This means that if oil prices changes will quickly affect the Japanese currency because the country has an economy that is dependent on oil.

Economies that are dependent on oil will be affected by high prices, as these high prices will be transferred to the supply chain ending up in very costly commodities. This has the effect of reducing the value of the currency of a country. To answer the question of whether oil market affects forex prices, yes it does although to a less or greater extent based on the currency pair. Some currency pairs will be more influenced by the oil price than others.

The future of crude oil is uncertain as of now and there are many different directions and outcomes we can expect to see in the following days, weeks and months. So basing from this argument alone, it’s easy to see that there are a number of factors that come into play in the forex trading arena. There are many factors that influence the behavior of the foreign exchange market but none can claim to be as influential as oil prices whose even the slightest movements are certain to rock the currency and the foreign exchange market as a whole.

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