Oil Prices and Currency Pairs

From 2014, when oil prices started slumping, big oil exporters like Russia, Canada and Brazil were threatened with recessions. Roughly 65% of Russia’s exports were crude oil in 2014 and, as a result, the country entered a recession the following year, which wasn’t helped by the sanctions imposed by Western countries in response to their invasion of Crimea.

It’s not only in oil-dependent nations that the economy is affected by changes in commodity prices. The selling contagion in 2014 went beyond oil to other commodities, which started to bind together oil prices with non-oil-dependent economies. At this time, there were concerns about deflation, which led to the European Central Bank (ECB) initiating quantitative easing in March 2015 as a way of combatting it, thus impacting the relationship between many currency pairs.

Oil prices are also a big contributor to inflation, and this tightens the bond between oil and the economy even more. Oil prices are quoted in US dollars, which forges a special relationship between the American currency and oil prices. Whenever oil prices shift, or dollar values change, the dollar currency pairs have to re-adjust. Let’s look at how the relationship between oil prices and currency has proved relevant in 2022, when Russian oil has been strongly sanctioned, and at how it touches on popular currency pairs like EUR/USD.

USD

America boosted its crude oil production in 2020 but the dollar did not suffer when oil prices dropped. One reason is that the energy sector is not the only contributor to US GDP. The economy is enriched from many different sources as well. Additionally, we must also consider that America’s economic growth has outdone its peers’ in recent years, which could have a knock-on effect on forex trading prices.

Readers who are involved in forex trading will know that July 2022 saw the EUR/USD pair fall down to parity for the first time in 20 years. There were a few reasons why the dollar asserted itself so strongly against the European currency, and commodity prices was among them. The eurozone was worried Russia would cut off its gas supplies, which could spur off a recession, so the European currency was less in demand.

The persistence of the Ukraine conflict and its resultant sanctions, which led to a big spike in oil prices, ended up helping the US dollar because of its safe haven appeal in times of economic uncertainty. Looking toward the second half of 2022, “It is not difficult to put together a case in which the euro could fall further”, says Jane Foley of Rabobank.

Commodity-Based Currencies

People interested in forex trading with the USD/CAD currency pair have a special reason to keep an eye on the arena of oil trading. Canada was the fifth biggest oil exporter in the world in 2019. When oil prices are high, Canada will earn more American dollars for every barrel it sells to the US.

Therefore, the supply of American currency in the country will grow relative to the supply of Canadian currency, and so the CAD tends to appreciate relative to the USD. When oil prices fall, the supply of USD relative to CAD can drop, and the CAD could depreciate relative to the USD.

If we look at the Russian ruble this year, we see again the power of oil to influence currency values. At the beginning of April, the ruble was worth less than an American penny due to the harsh sanctions Russia was having to weather. By the end of June, though, the ruble had gained a massive 45% for the year so far.

This was surprising because normally we’d expect the currency of a heavily sanctioned nation to suffer as a result of the departure of trade capital from the economy. But, largely because of skyrocketing oil prices, and the fact that Russia is a major source of oil, the currency experienced this elevation.

“Even though there is a drop in the volume of Russian exports due to embargoes and sanctioning, the increase in commodity prices more than compensates for these drops”, explains Tatiana Orlova of Oxford Economics.

Summing Up

If you’re part of the forex trading world, keep up with the progress of oil embargoes in Europe as well as with the path oil prices take in the near future. Another big factor in the forex world is the comparative tightness of monetary policy in one nation versus another, which has been a reason for the USD’s strength in 2022.

It remains to be seen if the dollar can keep up its strong showing this year and continue to dominate its partners, or if it may be due to come back to ground. Either way, the resulting volatility for both oil trading and forex trading prices could provide a hotbed of opportunity and risks for CFD traders.