David Bloom’s currency strategy team at HSBC looks at the issue of oil and foreign exchange rates on Monday, arriving at a clear-cut conclusion.
Determining which currency in which to park one’s money when oil prices are on the rise is dependent on one thing and one thing only — whether said price rises are the result of demand forces or of a supply shock.
Bloom’s team admit they are not in the business of predicting oil prices. However, they do know that an oil price rise driven by demand factors has very different consequences for the FX markets than an oil price rise driven by a supply shock.
The consequences, they say, are best summarised in this chart:
And unfortunately they feel it’s the black arrow scenario — the supply shock option — that we’re currently heading towards.
As they note, this is bad because it takes us to the demand destruction point:
In this scenario we get a supply shock that drives the oil price and this bad for risk because it creates demand destruction. “Other” commodity prices actually come under downward pressure, and one ends up buying the low risk currencies. This is good for the JPY and bad for the MXN. So depending on the reason for the rise in oil price rise, the reaction of MXN-JPY and other exchange rates will be totally different.
Furthermore, this path once again begins to echo what transpired in 2008.
In 2008, oil prices approached USD150 per barrel. Shortly afterwards, the global economy collapsed. There were, of course, other problems at the time – an imploding US housing market, the beginnings of a securitisation crisis, the collapse of Lehman Brothers – but events three years ago nevertheless offer plenty of evidence that substantial changes in oil prices are big news for the global economy. Indeed, for those who believe the global economy is ultimately fuelled by oil and gas (as opposed to, for example, excessive credit), events in 2008 simply confirmed a pattern seemingly in place since the 1970s. Chart 4 shows the level of oil prices in real terms (adjusted using the US consumer price index) tracked against US recessions (grey bars). Regular as clockwork, increases in oil prices of more than 100% lead to declining GDP…
Which brings us yet again — since it really is beginning to pop up all over the place — to the following chart reflecting the correlation between US recessions and oil price rises:
For more, check out the full report in the usual place.
Related links:
It’s not a liquidity crisis, it’s an energy crisis stupid - FT Alphaville
Emerging contagion – FT Alphaville
Nomura’s $220-a-barrel crisis oil call – FT Alphaville
Elasticity *alert* — or, at what point demand destruction? - FT Alphaville