Energy Prices, Inflation and Forex

[abdulla1]

Oil futures surged to a record intraday high of $70.85 on August 30th, the day after Hurricane Katrina made landfall on the Gulf Coast. While prices have moderated in subsequent weeks, it's worth examining how higher commodity prices and the specter of inflation impacts the foreign exchange (FX) market, particularly the U.S. dollar.

 

Traditional supply and demand factors certainly have contributed to the longer term trend in energy prices. The demand side of the equation has been getting plenty of press this year, with focus on the rapidly growing thirst for oil in both China and India. However, the recent spike in oil can primarily be attributed to hurricane related speculation in the futures market and the limited and centralized (on the Gulf Coast) refining capacity of the U.S.

 

Economic data released in recent weeks has begun to reflect the effects of hurricanes Katrina and Rita, which ravaged the U.S. Gulf Coast in August and September. These data reinforce what the Fed has been implying all along; that the economy is growing at a brisk pace and that inflation, not recession, should be the concern.

 

September jobs data showed the first net job losses since May of 2003, but the decline of 35,000 jobs was much smaller than the decline that was anticipated. September CPI showed the largest monthly gain in 25 years. However, when the volatile food and energy components are removed, inflation was a rather mild 0.1%. That was quite a bit less than the market was anticipating and suggests that the higher energy prices are not being passed through to the core number yet.

 

Similarly, the September PPI headline number exceeded expectation and was the largest monthly gain in 15 years. However, again we remove food and energy and see that wholesale prices were up a relatively restrained 0.3%. This core number did beat expectations though, so one might deduce that higher energy prices are starting to impact prices at the wholesale level and it's just a matter of time before these higher prices are passed along to consumers. Weaker than expected retail sales and a new 13 year low in Consumer Sentiment suggests that higher energy prices are indeed weighing on the American consumer's mind. How that will play out, particularly in the retail sector going into the holiday season is now a major focus on Wall Street.

 

With the word 'inflation' seemingly on everyone's lips these days, we expect the Fed to continue on its tightening schedule. The Fed raised the target for overnight borrowing in September by 25bp to 3.75%, the 11th such hike since June of 2004. Another rate hike is expected in October and at least one additional 25bp bump is all but assured in November or December.

 

Rising U.S. interest rates and an expanding U.S. economy have been the driving forces behind overseas flows into U.S treasuries and the stock market respectively. These flows translate into demand for the U.S. dollar, which has kept the greenback generally well bid in September and October. While we would contend that the equities market is vulnerable at this stage, the interest rate differential picture should continue to favor the dollar through year end.

 

High energy prices and inflation fears are not exclusive to the U.S. Central bankers and finance ministers from the Group of 20 industrial and developing nations are meeting in Beijing this month. A statement released on October 16th said, high oil prices "could increase inflationary pressures, slow down growth and cause instability in the global economy.'' This should benefit the dollar as well because in times of global economic uncertainty, the dollar is still considered a "safe haven" currency. While we may see other countries begin to tighten their monetary policies, U.S. interest rates will remain significantly higher.

 

The definitive move above USD-JPY 115.00 bodes well for additional dollar gains against the yen into the 118/120 zone. On the other hand, the July lows in EURUSD at 1.1868 must be convincingly negated to trigger further dollar gains against the European currency. Such a move would shift focus to the 2004 lows at 1.1759/78 initially, but potential would be for a drop below 1.1500.

 

In times of inflationary pressures, the U.S. dollar tends to lose ground against the commodity currencies. Commodity currencies are the currencies of countries that derive the bulk of their export revenues from the sale of commodities. Prime examples of liquid commodity currencies are the Canadian dollar, Australian dollar and New Zealand dollar.

 

The dollar hit a new 17 year low late in September against the Canadian dollar on the back of sharply higher oil and metals prices. While the dollar recovered from those lows, gains are considered corrective in nature and we look for the longer-term downtrend in USD-CAD to continue. Similarly, AUS-USD and NZD-USD are consolidating below important resistances with scope seen for additional short to medium term gains.

 

At some point, domestic inflation and the rise in the U.S. dollar will return focus to the U.S. trade deficit and balance of payments. As U.S. goods and services become more expensive, both domestic and overseas consumers will look elsewhere. That's the point where the U.S. stock market truly becomes vulnerable. Downside risk in the stock market will result in a negative impact on flows into the U.S. and consequently the long-term downtrend in the dollar would likely start to re-exert itself.

 

Conventional wisdom in the financial services industry suggests that placing 5-10% of one's portfolio in alternative investments, such as those offered by CFS Capital, is desirable to achieve the diversification necessary to protect against adverse moves in the more traditional asset classes.

[shoaybkhan]

Oil and Gas prices upsets the Forex too. Specially with the decreasing Us Dollar rate can inflate the market.

[surya77]

Oil price now is :  (bullish) 99.88s  +2.04 +2.09%   and Ethanol oil price : (bullish) 1.957s +0.038 +1.98%.

 

[Decub]

Those factors influence the economy of a nation too and then, take its turn on the Forex market. Most especially, the inflation rates of a country moves and shakes the countries economic conditions which results to a sort of weakening of their economy. This factor becomes a major reason why certain traders find it difficult to trade are certain news release.

[waseemilyas]

 individuals elements impression the monetary process of the country too and then, get its turn on the Forex sector. Most Mainly, the inflation expenses of a rustic moves and shakes the countries economical situations which ends to your type of weakening within their In general economy. This situation leads to being A major motive why selected traders discover it tough to trade are selected news release. 

[myregister]

All kind of commodity has its own effect to the market. like Oil or Natural Gas price since that is the main energy yet for this business to run. But there are other aspect that made the price of forex rise or fall and that is not only of the energy prices, but more to country performances in economy.

[pepy]

I don't know what energy prices could do but inflation surely affected forex and forex affected inflation, so vice versa it affected each other a lot. Natural Gas or Oil will affect but only to a country that use it as their main energy.

[myregister]

It will affect, especially in a country where something like Oil or Natural Gas become the main needs for that country so their economy will keep moving with it. Inflation for sure will affect that is what we called as CPI which become indicator for inflation.

[pepy]

It seems you are right it will affect the prices of some commodity and also forex itself, since they are related to each other. But the problem if someone is trying to manipulate the price in the market, it would be bad for one country economy it may crus them in long term.

[myregister]

It seems you are right it will affect the prices of some commodity and also forex itself, since they are related to each other. But the problem if someone is trying to manipulate the price in the market, it would be bad for one country economy it may crus them in long term.

Energy price, Inflation and Forex are having correlation to each other and that is quite big if you ask me. Forex the place where your money will change to strong to weak or vice versa, thus giving you more chance to buy more enerty, this invisble connection surely will affect forex more in future.

[pepy]

Oil itself is one of the greatest evidence that energy prices and forex also connected to each others and indirectly make inflation to so many countries around the world. I doubt that people who trade in enermous amount of money won't look this issue.

[myregister]

That is why i said in future this invisible connection surely will affect foreign exchange and of course we can see it already happening, also US Dollar that somehow become another commodity like gold or silver or oil. If US has bad time or recession, those commodities will getting better than ever.

[pepy]

@myregister: You said the truth, i also observed the same thing here gold or silver tend to have different movement towards USD. But what is your idea about inflation  and what do you think about its correlation with forex itself aside from for sure driving the price to higher price, and a good indicator for a country's economy.

[myregister]

It is an economic indicator, it's what drive people to think one country's economic health. If CPI is good then the economic growth expected thus make people give more value to USD or other currencies resulted in the rise or fall of one currency's price.

[pepy]

Energy could drive one currency to the higher or lower level but it is all depend on what kind of currency. US simply isn't one of them. You can see RUB as a good example of this, how the price of energy affect them. As for more developed countries, i think they affected mostly by inflation.

[myregister]

The latest news about this energy, price and inflation that affect one country economy or currency is Saudi Arabia. With the price of oil which keep falling it gives them quite nice deficit where they must cut off the subsidy for that. Energy in fact have such a good influence or even bad one to one country and it is proven for many years.

[Vaabum]

Very painful topics that are relevant to this day.