Currencies | Jul 15 2009
By Chris Shaw
For some time Silicon Valley Bank senior FX advisor Laurence Hayward has pointed to a correlation between the oil price and currencies, reflecting his view the oil price has been driven not only by commodity market speculators but by those speculating on currencies at the same time.
In other words, he suggests many of those speculators who bought into the oil market were also buying into currency markets such as the euro in an attempt to generate double returns by then selling both holdings as prices rose. Hayward now sees signs this correlation is breaking down, which has implications for currency markets in his view.
He offers evidence of the relationship breakdown in the fact when last week in the US there was talk of introducing new regulations with respect to commodities futures trading the oil price subsequently sold off, falling below US$60 per barrel for the first time since May having recently traded up to US$73 per barrel.
Those highs were not justified by fundamentals in his view as supply is reasonable, there is excess refining capacity and demand remains subdued, meaning the price was achieved largely on the back of speculative buying.
Hayward suggests the subsequent sell-off reflected speculators reducing their positions and taking profits ahead of any changes in regulations, but the more important element in the oil price fall was currencies didn’t move in correlation as had been the case for some time.
As an example, he notes on June 30 the euro was trading at 1.4033 against the US dollar but on July 9 it was trading largely unchanged at 1.4020, which shows the correlation is breaking down and is unlikely to return to previous levels in his view.
In other words, Hayward expects any changes in risk aversion levels should see those assets viewed as more risky receiving most of the market action, so if risk aversion increases commodities and some currencies may be sold lower, but the US dollar and the yen should avoid significant weakness given their status as safe havens.
Why would the US dollar not be sold off given the weakness in that economy? Hayward suggests there is still no alternative to the US dollar as the global reserve currency, supported by the fact US bond auctions continue to be very well received in the market given they remain the safe haven asset of choice and this buying of US bonds requires buying of US dollars to be effected.
In Hayward’s view the posturing by the Chinese of late about the need for a new global reserve currency is largely rhetoric and is being used to divert attention away from recent criticism of their manipulation of their own currency in the global market, especially as China is likely to show up as continued large buyers of US bonds at auction.
The implication of the breakdown of the correlation between the oil price and currencies according to Hayward is if those calling for a double-dip recession are correct, and he is one of them, then the US dollar and the Japanese yen should be beneficiaries, US bonds will rally and commodity prices will fall as the market chases less risky assets in favour of those with more associated risk.
