Any setback to the government in Southern Iraq could lead to greater demand for the more liquid currencies like the yen, the dollar and the Swiss franc.
11 hours ago
A sudden and sustained rise in global oil prices caused by violence in Iraq would initially trigger a rush into safe-haven currencies like the yen and the Swiss franc, despite Japan and Switzerland being importers of crude.
Ever since the violence escalated this month and drove oil prices higher, both currencies have held their ground, challenging a view that higher crude prices usually translate into big wins for oil-exporting countries and their currencies.
Higher prices improve the trade balance for oil exporters like Canada and Norway and push their currencies higher. Conversely, they tend to hurt oil-importing nations.
However, investors are wary that a supply shock could hurt global recovery prospects and hit the less-liquid and riskier commodity currencies at first.
“Such shocks usually do not bode well for general risk appetite as it raises concerns about global growth and tends to be accompanied by falling stock prices,” Petr Krpata, currency strategist at ING, referring to the recent spike in oil prices due to fighting in Iraq.
“In fact, within the G10 FX space, the dent to risk appetite tends to offset the positive effect of rising oil prices on exporters.”
Brent crude surged eight per cent since May to hit a nine-month high of $115.71 in mid-June on worries that sectarian violence in Iraq could hurt oil output. With Iraq contributing to about 11 per cent of the daily production from the OPEC oil producers’ cartel, any supply disruption would hurt.
So far, there is little sign of large scale supply disruptions and oil prices have eased, keeping action in the currency market rather limited. But currency investors are watching whether the fight extends into Iraq’s south.
Around 90 per cent of Iraq’s oil shipments are from there, an area so far largely unaffected by unrest. Any setback to the government there could lead to greater demand for the more liquid currencies like the yen, the dollar and the Swiss franc.
All three currencies are sought-after during financial market turmoil and uncertainty about the global economy. They have more or less held their ground this year, despite stocks soaring and riskier currencies performing well.
The Canadian dollar and Norway’s crown are down four per cent versus the yen so far in 2014 and both have underperformed the rise in oil prices which have risen three per cent this month.
“If it is an oil supply shock then we will see a move towards safe-haven currencies,” said Jane Foley, senior currency strategist at Rabobank. “On the other hand, a sustained rise in oil prices, which is not caused by a supply shock will tend to benefit oil producing countries like Canada.”
LOSERS AND WINNERS
Mark Mccormick, a strategist at Credit Agricole says the biggest beneficiaries of a sustained rise in oil prices in the past have been the growth-linked, commodity currencies like the New Zealand, Australian, Canadian dollars and the Norwegian crown.
Higher oil prices are not always bad for economies or financial markets. If gross domestic output is on a strong footing already, robust demand for energy, higher stock markets and growth-linked currencies can co-exist nicely, analysts said.
“But when oil prices result from supply shortages, both the reduction in quantity and the higher price will tend to hit economic activity,” said Jeremy Hale, a global macro strategist at Citi. “In fact, every U.S. recession bar one since the mid-1970′s has been associated with a spike in oil prices.”
The United States, though, is much better placed to tackle an oil shock given its dependency on imports is gradually waning.
In the derivatives market, implied volatilities show there is little sign of an oil price shock being factored in.
Currency volatility has been crushed, languishing at multi-year lows, highlighting most major currency pairs are likely to trade in a range and unlikely to see sharp and volatile swings.
ING’s Krpata warned that may change and an oil shock could see implied volatilities rise.
“This is not surprising as a period of stress and uncertainty tend to be associated with higher vols. The highest pick-up in vols is seen on historically higher beta currencies such as the Aussie, the New Zealand dollar, the Norwegian crown as well,” he said.