Correlations in Oil and Currencies

February 28, 2019

 

 

Economic diversity shows a greater impact on underlying currencies than absolute export numbers. 

When a country’s principal export is oil or a commodity, its currency exchange rate tends to track the global price of that export. When the price rises, so do the exchange rate. The rising global price tends to attract inward investment and resources to the extractive industry, while other export industries struggle due to the high exchange rate – a phenomenon known as “Dutch disease” in which the economy becomes increasingly dependent on its extractive industries. When the prices of oil and commodities fall, the currency exchange rates of exporting countries fall in tandem.

If the dollar weakens, crude oil prices should rise since oil is priced in dollars. If the dollar is cheaper, purchasers of crude can convert their local currencies into the dollar-denominated crude at a cheaper exchange rate, thus buying crude oil at a cheaper level based solely on the exchange rate.

The sharp increase in oil prices and oil price volatility over the past decade has coincided with a closer link between oil prices and asset prices, including exchange rates. There is a growing literature analyzing the link between oil prices and currency movements, showing that currency values of commodity exporters contain information about future commodity price movements, while commodity prices also have predictive power for commodity currencies.

 

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