The moment oil was discovered, the world started to change. Mankind, as it existed for thousands of years, suddenly found a product that would revolutionize the way things work in an economy.
When hearing of oil, people automatically think of driving a car. For most of us, oil relates to the gasoline we need when driving.
But oil is much more than that. Oil drives an economy, slips it into a recession or can influence its GDP (Gross Domestic Product). It made Middle East rise to a super-power out of nothing, and shaped economies around the world.
Today, as well as in the years and decades to come, oil will play a vital role in the world’s economy. Maritime transportation, aviation industry…these are only a few examples of industries heavily dependent on oil and oil prices moving forward.
In Forex trading, oil has a crucial role. Even though Forex traders like to think they do not trade oil, or oil related products, in fact, they do very much so.
Oil and Inflation
Inflation strongly relates with Forex trading. It is on the mandate of every central bank; their task is to keep inflation below or close to two percent.
A drop in inflation or, only in inflation expectations, translates in a dovish central bank statement. Typically, recession will set in the economy and the central bank will try to fight it with lower interest rates.
Lower interest rates drive a currency lower. But lower inflation is the result of lower oil prices. Hence, lower oil prices equal lower inflation which in turn equals lower currency rates.
This is the link everyone involved in trading financial markets must know; especially currency traders.
Oil and the Canadian Dollar
The Canadian Dollar (CAD) and oil have a special relationship. The entire Canadian economy is strongly dependent on oil.
To be more exact, on the oil price evolution; Canadian GDP (Gross Domestic Product – shows the total values of goods and services in an economy) falls or rises in a direct correlation with oil prices.
Lower oil prices, lower revenues for the Canadian economy. The other way around is valid as well.
The Canadian economy is an energy driven one, so the evolution of the energy sector, both locally and globally, influences the economy. When the economy shifts based on oil prices, the central banks shift the monetary policy accordingly.
When the momentary policy shifts, the currency fluctuates. Therefore, when trading a CAD pair, keep in mind that the oil price evolution is more important than the regular pieces of economic data released in Canada.
Oil inventories, refineries capacity, and so on…these are drivers for the CAD currency pairs. USDCAD is the most popular and liquid CAD pair, and yet it experiences wild swings when oil price moves.
OPEC Meetings and Decisions
OPEC (Organization of Petroleum Exporting Countries) meets regularly to discuss oil supply and demand levels. Obviously, because the important role oil plays in the global economy, the one who can control and influence its prices has a lot of power.
OPEC is one of these institutions. Its decisions make oil prices swing aggressively. Consequently, the Canadian Dollar moves too, and the overall Forex market experiences high volatility levels.
Vienna, Austria, is the place where OPEC meetings take place. Financial journalists from all over the world gather to report on the evolution of these meetings.
The decisions taken there, whether to cut or increase production levels, to hold them at current levels or not, results in wild swings in all financial markets across the world. So important is oil for the Forex market!
Global Deflation Spiral
Recent years saw the world dipping in a dangerous economic environment; deflation. When deflation happens, consumers do not spend their money and saving tendency increases.
For a central bank, this translates in a problematic situation; they can lower rates to zero, as they did, and even go beyond with unconventional measures. The aim is to fight deflation by all means.
What people and traders should know is that the dramatic fall in oil price from over $100 to the $30 area is directly responsible for this deflationary environment. The drop was so fast that it quickly affected financial markets.
In a few months’ notice, the world was gripped in low-inflation territory and deflation loomed. Central banks reacted, and the race to lower interest rates across the globe started.
Everyone wanted a lower currency. As a result, the Forex market volatility increased and speculators profited from these large swings.
The examples used in this article have the purpose to bring to your attention oil’s importance in the world we’re living in. Despite the general public’s belief that oil’s importance will diminish with electric cars, it is not correct.
In fact, oil and oil related products will shape the future of monetary policy for many years to come.