In a recent note to clients, Morgan Stanley’s FX research team revealed some surprising relationships between oil and different currencies.
Essentially, their analysis boils down to one simple point: because high oil prices are currently being driven by supply-side issues, the relationship it has shared with currencies during the last few years is breaking down. We can see that in both commodity currencies like the Aussie dollar and reserve currencies like the euro.
Euro strength recently has been buoyed in part by Middle Eastern central banks buying up large quantities of the currency every time its value dips significantly. But because oil prices are being driven by supply-side issues like political tensions, central banks in the Middle East and Russia appear to have stopped beefing up their cash reserves:
From the Morgan Stanley Report:
Oil-exporting countries would be expected to see an increase of reserves as a result of higher oil prices under normal circumstances, especially if higher oil prices are being driven by higher demand. However, we suggest that the relationship may not necessarily hold in the situation where higher oil prices are being driven by supply issues…
Photo: Morgan Stanley
We suggest that with reserves remaining flat there was little need to reallocate to alternative currencies, including the EUR, in the second half of last year. However, there is evidence in the available data of an over-allocation to the EUR by global central banks in the middle of 2012. Historically, when such a development has occurred, this is corrected in subsequent quarters.
They argue that a different, but equally important, change is going on in commodity currencies, which generally rise in value along with oil prices:
There is also a clear change in the relationship between the commodity currencies and oil prices when oil prices are driven by supply issues rather than demand. Our studies found that in these cases, commodity currencies did not gain any support from supply-driven oil prices rises. Hence, we remain cautious regarding the current recovery of high-beta commodity currencies in the current environment. We have found this development to be most emphasised in the case of the AUD, where there is a clear breakdown in the correlation when oil prices are driven by supply concerns rather than by demand.
They point to this chart to demonstrate that breakdown:
Photo: Morgan Stanley
Ultimately, they emphasise—as have analysts from Bank of America—that high oil prices are a major threat to global growth.