The Price of Oil and the FX Market’s Reaction
InvestingOnline.com
27/07/2018, 13:29For many retail Forex traders, the price of oil doesn’t mean much. Some don’t even care if it goes up or down or if it moves at all.
But this type of ignorance ends up being expensive. For if there is one commodity that influences all financial markets, that’s oil.
The Price of Oil and Reasons Why It Matters for the FX Trader
Like any commodity, the price of oil depends on the supply and demand imbalances. Hence, producers and consumers may influence how much oil costs.
On the producer side, countries gathered and formed the OPEC (Organization of Petroleum Exporting Countries). Through coordinated action, they can quickly move the market by reducing or increasing production levels.
Oil inventories all over the world tell much about the state of the global economy. Higher inventory levels lead to lower oil prices and dropping inventories to higher ones.
At first glance, any Forex trader noticed that the Canadian Dollar (CAD) enjoys a direct correlation with the price of oil. Higher oil prices, the higher CAD!
Hence, traders that regularly buy or sell a CAD pair, effectively trade oil. Even though, they might not know it.
The big thing with the price of oil is that it influences inflation. The higher the price of oil goes, the higher the inflation becomes. Energy prices, transportation, they all move up in sympathy.
The opposite happens on a drop in oil prices. Inflation drops and, if the price of oil doesn’t recover, inflation may turn negative. Hence, deflation, another economic evil, settles in.
Because all central banks have a mandate that monitors inflation, suddenly the price of oil becomes vital for central bankers and traders alike. To fight lower inflation, central banks cut the interest rates, easing the monetary policy. To counterattack higher inflation, central banks hike the interest rates, tightening monetary policy.
In doing that, they create volatility on the currency market as the interest rate differential on various currency pairs will change. But the central pillar of the Forex market is the world’s reserve currency: the U.S. Dollar.
When the dollar moves, the entire financial system moves, and all financial markets in sympathy.
Conclusion
To sum up, the price of oil is the one that can easily trigger a central bank’s reaction to interest rates. Hence, instead of looking for economic data to justify a trade, perhaps retail traders should focus more on what moves the price of oil and how to get an edge on the FX market by analyzing the oil one.
