OIL Prices Matter More Than You Think

Oil prices have been increasing over the past three weeks after the price reached the significant lows of $67.00. 

But why does the price of oil matter? 

Oil makes the world go round. It is used in almost everything in life, if you want to receive a product from Australia in the UK for example, best believe oil plays a huge role in the development of the product and the transport of it. 

Not only that, but oil prices play an important role in influencing the currency and financial markets. 

You see, oil prices have a strong correlation with inflation rates. Not many retail traders know this. They open up the economic calendar, see CPI on the list and just watch the numbers without understanding where it came from. 

Well, if you want to find out the CPI number, just have a look at the past month's performance of Oil. Energy makes up a large percentage of CPI or the Consumer Price Index. 

Take a look at the chart. 

We can see that when the oil price rallies, CPI does too. On the opposite side if the oil price falls, then CPI does too. 

Pretty neat!

Oil prices also impact currencies, especially those that export and import a lot of oil. 

The top oil exploring countries include:

Now out of these countries we tend to only trade the United States dollar (USD) and the Canadian dollar (CAD). But if oil prices rise it can have a positive impact on these currencies. If the price of oil falls, then it can have a negative impact. 

The reverse can be said for those countries that import a lot of oil. 

The top oil importing countries include:

You may think why is the United States here again? Well the country is so large they don’t have enough resources to cover it all, so they often import oil too. China and Japan are also big oil importers. When the price of oil rises this can have a negative impact on these countries. When the price of oil falls it can have a positive effect. 

Oil also plays a pivotal role in the risk on or risk off sentiment in the market. When a global recession is on the horizon, we tend to see the price of oil fall, as an economic slowdown could impact global supply chains. 

A great example of this was the pandemic in 2020. Feels like a blur, but oil prices fell to $1 a barrel in a blink of an eye, as markets were fearful that life may never be the same again and global trade stopped overnight. 

But Jon, why should I care about this right now? 

That’s a great question, because the overall sentiment of the oil market right now is bearish. And this could have a long lasting impact on the price of the currency markets. 

At the start of the year oil prices turned on a dime when President Donald Trump re-took office. One of his key messages was “Drill, baby, drill” because he understands that lower oil prices will see inflation move lower.

When inflation is below 2% we often see the central bank cut interest rates. That’s what Trump really wants. He wants a lower interest rate so that government debt costs less. 

The price of oil is ultimately moves on supply and demand. If the production of oil goes up, then that means there’s more supply in the economy, more supply leads to cheaper prices. Trump wants America to produce more, driving prices lower.

To back this up, OPEC, an intergovernmental organisation of 13 oil exporting countries, have also said they will produce more in 2025. If that is the case, then oil prices could continue to trade lower. 

This is how it works…in my head anyway.

This is proven to work if you think about what is happening with the USD right now. 

Oil prices have been falling since the beginning of the year, this has led to US CPI falling to 2.8% annually. And because of this US10Y (government bond yields) have been falling, causing the USD to fall with it. 

Now I will blow your mind. (maybe a slight exaggeration).

This chart shows the Crude Oil price (black line) vs the US10Y (red line) vs the USDJPY (purple line). As you can see through 2020 to 2022, oil prices have been the lead indicator. 

Oil prices rallied first, followed by the US10Y, followed by the USDJPY price. How handy is that? Now that being said you have to make sure the correlation between them is there in order to get the use out of it, but this correlation is a very strong one. 

So the next time you breeze through the charts and go straight past oil, take a pause, have a look at the recent price movements and think. How will this impact the market? 

With that, I hope you learned something new! Peace!