Why A Little Reported Speech Matters For Oil

There is a tendency amongst retail traders and investors to look at markets in isolation. Many are aware that dealing room and floor traders are incredibly specialized and feel that their best chance of success is to be the same. It is true that for most of my trading room career for example, I worked with one specific currency pair and one time period. That doesn’t mean, however, that I ignored other markets. We were taught early on that financial markets are all inextricably linked and that what happens in one can have a profound effect on others. That is particularly true in the oil market with reference to currency moves.

More specifically it is true when it comes to moves in the Dollar. Oil is priced in Dollars on the global market, so if, for example, the Dollar declines in relative value then the price of oil must go up. If Dollars are generally worth less, then it will take more of them to buy one barrel of oil; it’s just common sense. That is why a speech given in New York last night (Thursday, October 1st) that has received very little attention could be extremely significant for oil over the next few months.

That speech was not given by a Fed board member as you might expect, but by ECB Chairman Mario Draghi. Draghi stated that the Eurozone economy had gone back to “Sustained growth” and, somewhat immodestly, said that that was “under the impulse of our monetary policy.” The pride there is, however, understandable. When Europe first showed signs of slowing Draghi fought hard for accommodative policy, mainly against the ECB’s most powerful member, Germany. The Germans have sound historical reasons for being fearful of inflationary policy, but once deflation became a real threat, not even they could sustain their opposition to some form of QE.

Now obviously, if Draghi is right and Europe is entering a period of sustained growth that would be good in some ways for oil. A strong Europe would offset a lot of emerging market weakness. It is, however, the forex implications of his claiming success that may have the biggest effect. Now that the evidence suggests that growth has returned, the Germans will be pressing for a return to their preferred state of tighter monetary policy. If you combine that likelihood with the growth itself, you have a recipe for a significant move up in EUR/USD over the next few months. And, as the dollar loses relative value, so the price of oil will be pushed up.

Now obviously this doesn’t take into account other significant factors. If supply remains elevated and the slowdown in emerging markets is really severe, then $45/Barrel will quickly start to look expensive, regardless of the exchange value of those Dollars. From a trading perspective also, I still believe, as I said a few weeks ago, that there are traders itching to try out the lows below $40 in WTI, so any short term weakness is likely to be exaggerated. If that weakness comes, though, the likely long term implications of Draghi’s speech mean that it should be seen as a buying opportunity for oil and energy related stocks, not a panic signal.