How Does the Volatility of Oil Prices Affect the US Dollar?

In many ways, oil prices will always remain synonymous with emerging economies and their individual currencies. This is because the vast majority of emerging economies depend heavily on the production and the sale of oil, whilst many of these nations are also established as large-scale exporters of this commodity.

With this in mind, it’s little wonder that oil’s increased volatility since the Iraq War of 2003 has impacted emerging economies the hardest, as issues such as dwindling demand and overproduction have caused prices to fluctuate from highs of $100 per barrel to a paltry $40 per barrel in 2015.

The decision of major economies to signal changes in interest rate policies based partially on oil prices has also impacted on global growth, meaning that established nations such as the U.S. are now increasingly affected by oil prices. But how exactly does oil price volatility impact on the greenback?

The Impact of Price Volatility on the USD

The U.S. Dollar (USD) and oil have enjoyed a particularly interesting relationship of late, particularly since the discovery of the Wolfcamp Shale and the overlying Bone Spring Formation back in 2013.

It’s estimated that this site was home to a staggering 46 billion barrels of oil, whilst it has dramatically increased the nation’s production of the commodity after years of marginal decline.

Of course, this discovery did little to improve price points and the existing imbalance between supply and demand, which had previously compelled OPEC to introduce a production cap on all member and non-member nations.

It also left the U.S. economy and the greenback increasingly vulnerable to oil price shifts, especially when you consider the direct correlation that exists between the cost of gasoline or airplane fuel and the price of transporting good and people internationally.

So, whilst declining oil prices were once welcomed in the States as they lowered the price of importing oil and passed savings directly onto the consumer, they’re now treated as something that could hurt U.S. businesses and oil industry workers due to the rising cost of exports.

Appraising the Price of Oil and Specific Currency Pairings

But what does this mean for the currency in real terms? Essentially, the greenback has become an increasingly commodity-driven currency, meaning that it’s price movements are likely to correlate more closely with the cost of crude oil.

As a result, the USD has become marginally more volatile and less predictable, which is why so many are backing currency pairing that also includes safe-haven assets such as the Japanese yen (JPY).

This was borne out recently by the forex trading platform Oanda, which showed that renewed weakness in crude oil prices had undermined previous growth in the usually reliable USD:CAD pairing.

Whilst talk of a further base rate cut helped to minimize losses, the pairing is unlikely to make further gains for as long as the current level of oil price volatility continues unabated.

The Last Word

In some ways, it’s ironic that the USD is being adversely impacted by volatile oil prices, especially as North America’s increased production of the commodity and their reluctance to accept OPEC’s caps have contributed heavily to falling prices over the last few years.

Many will argue that these negatives are vastly outweighed by the future profitability of the Wolfcamp Shale site, of course, but currency traders should definitely keep a closer eye on the price of oil if they tend to back or hedge against the greenback in the near-term.