Currencies and Oil

The relationship between oil and currencies is no more stable that the relationship between the S&P 500 and currencies. As we noted yesterday in our look at the correlation between a handful of currencies and the S&P 500, it is not that there is no relationship, but rather that the relationship is far from stable. One cannot deduce the correlation from first principles, but investors should monitor the shifting  sands.

A note on our methodology. We are looking at correlations conducted on the percentage change of the currencies and the second oil contract to avoid the effect of the roll.

EUR: Over the past 30 days the euro and oil have been 0.66 correlated. In late Jan there was a slight (-0.06) inverse correlation and it reached a peak near the middle of May near 0.74. Over the past 60 days the correlation is about 0.52. In early April it was 0.03.

There is a logic to the correlation. The ECB is raising interest rates primarily due to headline inflation. Oil, or energy more broadly understood is a key driver of euro zone inflation. Higher oil prices would seem then to raise the prospects of further ECB tightening. However the correlation is far from stable and given the loft level of the 30-day correlation, the risk is that it slackens in the period ahead.

NOK: Over the past 30 and 60 days, the krone has the tightest relationship with oil prices among the currencies we looked at. The 30 day correlation is 0.88 and the 60 day is at 0.66. But it too is far from stable. in early March the 30 day correlation was in the mid-teens and the 60 day correlation was near 20. That means that there are times when NOK is not a good proxy for oil and times when it is. One cannot know it a priori.

CAD: Over the past 30 days CAD's correlation with oil is about 0.67 and over the past 60 days it is 0.49. As we have noted, western Canada may export oil, but the eastern provinces import more expensive oil. The relationship is far from stable. There was an inverse correlation for both time periods in March.

GBP: The UK is an oil producer, but overall the UK is a net importer of energy. Sterling's correlation with oil over the past 30 days is 0.56 and over the past 60 days is 0.35.

This fits into the general pattern whereby the correlation between the currencies and oil has increased over the past 30 days (30 day correlations are consistently greater than the 60 day readings). However, levels are being approached which suggest the next move is likely to be some easing of the correlations. This does not necessarily imply direction, but does suggest the fx participants may be less successful in looking at oil for directional clues.
Currencies and Oil Currencies and Oil Reviewed by Marc Chandler on May 19, 2011 Rating: 5
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