Why Currencies Were Less Oil-Linked in 2018

At a Glance

  • The Canadian dollar and Russian ruble, traditionally linked to oil prices, were moved by other factors.

OPEC’s decision to cut oil production beginning in January 2019 might have been expected to boost oil-linked currencies, but other factors are taking their toll.

The currencies most closely associated with crude oil prices are the Canadian dollar (CAD) and the Russian ruble (RUB), although the former is also heavily influenced by U.S. interest rates.

Canadian Dollar

Correlation between the CAD and oil has risen in recent months and the loonie has been boosted by a cut in production in Alberta that saw Western Canada Select crude surge more than 70 percent, narrowing its discount to the U.S. benchmark, WTI. However, Vincent Cignarella, currency strategist at Bloomberg notes that trade and fundamentals often have a greater impact on the value of the CAD.

A JP Morgan report on the outlook for the CAD in 2019 has USD/CAD remaining elevated at the beginning of the year on weak local oil prices and NAFTA/USMCA concerns before drifting lower as oil prices recover.

The report notes CAD’s relative insensitivity to oil prices in 2018, with average correlation this year almost zero compared to 75 percent between mid-2014 and mid-2016. The authors suggest this is less because oil prices are irrelevant and more that rate spreads and the pricing in of broader cyclical dynamics have dominated the currency’s performance.

As with the Fed, monetary policy expectations for the Bank of Canada are also starting to come down says Ed Moya, senior market analyst at OANDA.

“Expectations for a January hike are now called into question and the baseline case for three hikes next year should come down,” he says.

Russian Ruble

The ruble has had a similar increase in its correlation to crude prices of late on the back of OPEC announcements, adds Cignarella. “The outcome of the most recent OPEC meeting resulted in the ruble gaining 1.3 percent,” he says. “However, sanctions – or threats of sanctions –- from the U.S. has interfered with oil correlation during 2018.”

Russian government budget policy is a further complicating factor according Deutsche Bank research analyst, Michael Hsueh.

“The decision to temporarily halt FX buying under the fiscal rule provides additional support for the RUB,” he explains. “Q1 will be particularly challenging given higher inflation due to the VAT hike and the resumption of FX buying.” We therefore expect the central bank to keep its cautious approach and provide additional support through another 25bp hike, in early 2019.”

This leaves the CAD with a stronger sensitivity than RUB since the peak in oil price in early October. Hsueh expects the CAD to respond more in line with historical betas than the RUB.

RUB and Low Oil Prices

Russia, the third largest oil producing nation, has a higher pain threshold for low oil prices than the U.S. or Saudi Arabia since it can balance its budget with oil in the mid-$50s. Another benefit for Russian oil firms is that when oil prices are hammered the ruble usually suffers, which means their production costs fall.

Moya agrees that expectations are growing for the Russian Central Bank to raise rates over the next few months but adds that in the short term the central bank may adopt a hawkish hold.

Ehsan Ul-Haq, lead analyst oil research and forecasts at Refinitiv believes that Russia’s policy of buying foreign currencies for its sovereign wealth fund when oil is above $40 a barrel might help the country shield its exchange rate from excessive fluctuations in the future.

U.S. Production Affecting Currencies

Developments in the U.S. have also affected the oil industry-currency dynamic, namely the structural shift in shale production (which has changed the oil import component of the U.S. current account) and the interest rate environment.

Certainty around supply has declined, in part because the shale sector can bring supplies to market based on weekly price moves, notes Ed Al-Hussainy, senior currency analyst at Columbia Threadneedle Investments.

“If we look at surprising developments over the course of 2018, the Norwegian krone and the Colombian peso would have been expected to outperform on the basis of oil price rises, but this did not happen,” he says.

Nations such as Saudi Arabia that have pegged their currencies to the U.S. dollar have avoided currency fluctuations and reduced uncertainties in international transactions, but at the expense of lower economic growth.

Although the level of production does not have any impact on these countries’ currencies under normal conditions, the dollar is showing some correlation with U.S. shale oil production levels, says Ul-Haq.

“Oil producers have taken a number of steps to mitigate the impact of oil prices on their currencies, including increasing interest rates, reducing oil production costs and limiting dependence on oil revenues, but it is unlikely that they can completely break this relationship,” he concludes.

“In fact, rising oil supply has the potential to send oil prices down significantly and lead to more downward pressure on oil exporters’ currencies.”

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