This Great Graphic, created on Bloomberg, shows how well the euro (white line) appears to have tracked the price of the front-month Brent futures contract. One of the reasons this week proved so challenging for foreign exchange traders is that this apparent relationship broke down. Oil prices fell around 10% while the euro actually advanced against the dollar.
The eurozone is a large importer of oil. Why would the euro fall in tandem with oil prices when it, like the US, Japan, China and other oil consumers are helped at the expense of oil producers? The logic has too chains of reasoning. The first is that the decline in oil prices is seen to be partly a function of a slowing global economy. The eurozone needs stronger world growth if foreign demand is going to help pick of up the slack of domestic demand, depressed by weak activity and high unemployment. If the foreign demand is weaker than prices (the euro) has to bear a greater burden of the adjustment.
The second comes from the policy reaction loop. Falling energy prices will drag down eurozone inflation. Investors expect the ECB to deploy more unconventional policies to restore what it calls 'price stability', which is something close to, but lower than 2%.
We looked at the correlation between several currencies and the front month Brent futures contract over the past hundred days on a simple value basis. The numbers below represent the percentage of time the currency and Brent moved in the same direction.
