What is the Relationship Between Oil Price and Dollar?

In the forex trading arena, one of the chief factors that causes one currency to grow stronger than its counterpart is economic strength. A nation that is perceived to be economically healthy will draw lots of capital from foreign sources, which will prop up its currency. By contrast, the assets of a country whose economic outlook is bleak will be less attractive to foreign traders, thus drawing sparser inflows and keeping their currency on the back foot. 

In the complex dynamics guiding all this, oil prices take on a very central role. We saw a straightforward example of this in 2022, when oil prices surged in Europe due to the Ukraine conflict. The result was to fan inflation and discourage households from purchasing, which put an unwelcome restraint on the economic recovery (from Covid-19) underway on the continent. The impact on Europe’s single currency – the euro – was clear: it depreciated throughout the year to the point where $0.95 could buy you one euro in September. At that time, crude oil prices held at an elevated $100 a barrel (bbl.)  

In a much more direct fashion, too, shifts in oil prices cause readjustments in the exchange rates of currencies. That’s because of the quote of the crude price in USD. The fixing of the crude oil rate in dollars implies that a stronger dollar will lower demand for oil from foreign currency holders, since the commodity would grow pricier from their vantage point. When the dollar weakens, crude oil becomes more attractive to those buyers, causing its prices to rise. Looking in the opposite direction, changes in oil prices also affect the value of the US dollar.  

It’s important to realize that, when it comes to the factors pulling the strings behind currency pairs, their ways of interacting vary a lot from one historical moment to the next. It’s very rarely the case that we can say, “Since the USD dropped by X amount, we know that oil prices will surge by Y amount”. To enhance our understanding, we’ll now examine the ties binding oil prices with currency pairs more closely. 

Crude Oil Price Effecting FX - 2014: A Case Study 

In the middle of 2014, crude oil prices started sliding. The main reason was an increase in production in the United States, which flooded the market with a glut of supply. Indeed, the year saw a 1.2 million-barrel-per-day surge in outflows from the USA, representing a huge 16% surge in production relative to the previous year. The results were that, between June and December 2014, Brent crude oil plummeted from $112 bbl. to $62 bbl., and the other global oil benchmark – West Texas Intermediate oil – dropped from $105 bbl. down to $59 bbl.  

The effects of this dramatic trend on exchange rates varied, depending on the nature of the economy in question. In the case of countries that were net oil exporters, like Brazil, Russia, and Canada, the impact on GDP and currency values was decidedly negative. That’s because demand for the nation’s assets and, by extension, confidence in their economic futures, took a serious dip. For instance, comparing GDP in Brazil from 2014 to 2015, we see a marked plunge from $2.46 trillion to $1.8 trillion. For Russia, it was from $2.06 trillion to $1.36 trillion, and for Canada, from $1.81 trillion to $1.56 trillion.  

Homing in on Russia, for whom crude oil made up 65% of its exports in 2014, the nation descended into a recession and the ruble tumbled. Since oil accounted for a full 50% of Colombia’s exports in that year, the Colombian peso plummeted too, losing a massive 39.4% in its matchup with the US dollar between July 2014 and March 2015. The Colombian central bank explained that their currency was falling “because an important part of the drop in oil prices appears to be permanent”, implying that the country’s general economic outlook had taken a turn for the worse. Still, the drop in the peso didn’t totally come down to falling oil prices. It was also helped along by a strengthening of the US dollar against most of its currency peers. 

How Do Oil Prices Affect the Market?

Net oil importers like Europe and Japan tend to see improved GDP (and thus stronger currencies) when oil prices go down. This happens because their import costs decrease, improving their balances of trade. The USA was also a net oil importer until 2020, when their own crude oil facilities started pumping out much higher volumes. Between mid-2014 and early 2015, though, the dollar’s bullish trend in currency trading wasn’t chiefly due to the drop in oil prices.  

Rather, it can be explained by the relatively brisk resumption of economic activity in the US following the 2008 financial crisis, which led forex traders to expect interest rate hikes from the Fed in the second half of 2015. In stark contrast, other developed economies, in Europe for example, were on a dovish path in terms of monetary policy, which held back the euro in its rivalry with the USD. This led to consistent selling pressure on the EUR/USD currency pair into Q1 2015.  

Despite America’s growing prominence as a producer after 2020, its currency was not adversely affected by the drop in oil prices from their September-2022 high. Again, a big reason for this was the country’s economic outperformance relative to its peers. Another reason was the diversity of its economy, which doesn’t share Colombia’s intense reliance on a single export. 

Summing Up the Correlation Between Crude Oil and Currency

Undeniably, the movements of oil prices and national currencies are intimately linked. The precise influence of the crude oil price in FX is difficult to pin down in any given case, but it can depend on things like a nation’s balance of trade, economic diversity, and status as a net importer or exporter of the commodity. In addition, each historical moment has its own mix of political forces and conflicts, which lend their own spin to forex trading dynamics.