Oil & Currency Markets
Learn forex Nitty Gritty. Discover Forex Magic Machine. Wall Street watches oil prices like a hawk. Remember the early part of 2008 when oil prices skyrocketed from near $70 to almost $150 within a few months. This was more than a 100% increase in oil prices. Many hedge funds heavily betted on the increase in oil prices and made a windfall.
Most of the increase in the oil prices was due to speculation. When the stock markets crashed, most of the hedge funds had to liquidate their investments in oil futures. The prices came down. The prices are down due to low consumer demand in a recession. But it is being predicted that with a recovery in the economy, the oil prices will go up again.
As oil prices go up, consumers have to spend more on oil. The more they spend on oil, the less they spend on other products. The less they spend on other products, the less profit other companies make. Declining profits means declining stock prices.
The opposite case is also true. The less the oil prices become, the more Wall Street becomes exuberant about the profit potential of companies. This increased exuberance translates into increase in stock prices. Two large futures exchanges are used to determine the prices of crude oil. One is the New York Mercantile Exchange (NYME) and the other is the International Petroleum Exchange (IPE).
Historically, rising oil prices have been associated with falling stock markets. NYME is where most of the crude oil futures are traded. By monitoring the movement of the crude oil futures in NYME, you can develop a feel of the future economic situation of the United States. Since oil is heavily traded in US Dollar, this affects the US Dollar. The net effect is however a bit complicated.
Let’s take a look at it. When oil prices increase, the demand for USD also increases as most of the countries need USD to pay for their oil bills. Increased demand for USD means that it should become stronger and appreciate.
But this is not the whole story. Increased oil prices also take its toll on the US economy. The question is which effect is more important for the forex markets.
The effect varies from one currency pair to another currency pair. If you are watching a currency that involves the USD and a currency representing a country that does well during the times of high oil prices like Canada that has huge oil reserves after Saudi Arabia, the effect would be drop in the value of USD/CAD pair. US imports more oil from Canada than any other country. If you are watching a currency pair that involves USD and a currency whose economy is hampered by the rising oil prices, the demand for USD will rise.
So some currencies have positive correlation with oil prices and other currencies have negative correlation with rising oil prices. The currency pair CAD/JPY shows the strongest reaction to rising oil prices. Japan imports almost 100% oil.
So when oil prices rise again, watch for a currency pair that has the strongest correlation with oil prices like CAD/JPY. CAD is positively correlated with oil prices and JPY is negatively correlated. So CAD/JPY can be a very good currency pair to trade during times of rising oil prices.
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