FLUCTUATIONS OF OIL PRICES

Fluctuations of oil prices



Fluctuations of oil prices

Introduction

Oil prices and the US Dollar exchange rate tend to move together. Figure 1 plots oil prices against the US Dollar nominal e¤ective exchange rate. No clear relationship is apparent for the early part of the sample, but oil prices and the US Dollar appear to be negatively related in recent years. As the Dollar depreciated between 2002 and 2008, oil prices surged. Conversely, during the .nancial crisis oil prices collapsed, while the Dollar appreciated. Figure 2 shows the correlation between oil prices and the Dollar, computed over 6-month moving windows. While the correlation .uctuates between negative and positive values for most of the sample, it turns more persistently negative after 2002. What economic relationships are behind this comovement? Do oil shocks drive exchange rates, or do exchange rates a¤ect oil prices? Or does the comovement of oil prices and exchange rates re.ect movements in other variables, such as for example the US or global growth outlook? Financial market commentary routinely suggests a causal relationship between oil price movements and changes in the value of the US Dollar as the following quotes illustrate:

Weak dollar central to oil price boom,

Strong Dollar presses crude oil

Oil settles lower on stronger dollar

ample supply,

Dollar index strength may tumble oil prices in 2011

Crude lower on stronger Dollar.

While the relationship between oil prices and exchange rates is widely discussed in the popular press and among market practitioners, the academic literature on this topic is relatively scarce. One strand of the literature6 investigates the long-run relationship between US Dollar real exchange rates and the real price of oil. Using monthly data on either US Dollar trade-weighted exchange rates or Dollar bilateral exchange rates versus advanced economies, this literature generally .nds that real exchange rates and the real price of oil are cointegrated and exhibit a positive long-run equilibrium relationship: that is, higher oil prices are associated with an appreciation of the US Dollar. Furthermore, the literature generally .nds that oil prices Granger-cause exchange rates, but not vice-versa.

Coudert, Mignon and Penot (2008) present evidence that both real oil prices and the US Dollar real e¤ective exchange rate are cointegrated with the US net foreign asset position, and argue that this suggests that the in.uence of oil prices on exchange rates runs through the e¤ect of oil prices on US net foreign assets. Cheng (2008) estimates a dynamic error correction model using data on commodity prices, the US Dollar e¤ective exchange rate, world industrial production, the Federal funds rate, and commodity inventories. Dollar depreciation is associated with higher oil prices, with the e¤ect being strongest in the long run (after several years).

This result is consistent with the idea that exchange rates are determined by traders expectations about future macroeconomic shocks; for small commodity exporters, commodity prices are an important and rel- atively exogenous source of economic fluctuations. In contrast, the authors argue that commodity prices are less forward-looking because commodity markets are more regulated and mainly influenced by ...