The dollar posted its third consecutive weekly decline against the euro as the U.S. housing slump and record oil prices slow growth in the world's biggest economy.First of all, the statistical correlation between euro and oil price implies absolutely nothing about the causality between oil and dollar. Both euro and oil are priced in dollar term, so if the dollar depreciates against everything else (euro, sterling, yen, gold, and oil), you'd precisely expect a positive correlation between euro and oil. In fact, the closer the correlation is to 1, the more likely that we're having an exogenous shock that comes from the dollar factors, and not the oil factors or the european factors.The dollar fell against 13 of the 16 most-traded currencies this week as oil touched a record $135.09 a barrel yesterday on the New York Mercantile Exchange. The U.S. is the world's biggest importer of oil. Oil traded at $131.87 today.
The correlation coefficient between oil prices and the euro dollar exchange rate has been 0.95 for the past year, indicating they have moved in the same direction 95 percent of the time.
This accounting correlation is masking what's going on underneath. There's probably a real but complex causal mechanism between oil, dollar, euro and everything else, but it will not be easily identified by just looking at the simple correlation or multiple plots.
At the very least, if we were to test the hypothesis that an increase in oil price is bad for dollar, then we are looking for a relationship between the oil price in effective terms, and the dollar in effective term (say some trade-weighted index). To the best of my knowledge, such strong and systematic statistical relationship cannot be found, and there's no compelling reason why it should be found. US is the world's biggest importer of oil, yes, but that's an absolute measure, plus the energy use efficiency needs to be taken into account. And should the Asian countries stop subsidising their oil prices (as Stephen Jen at Morgan Stanley recently wrote they might have to soon), no doubt you'll see that US is by no means the most vulnerable to oil price shock.
Incidentally, on exactly the same day, Chicago Tribunal ran the headline "Dollar's Drop Fuels Oil Rise". Know what I'm saying?
3 comments:
Some question krub Ajarn, if the headline news "Dollar Falls as Oil Goes Up" is really occured, why should we expect positive correlation btw USD & oil price ?
And, what do u mean by "the dollar in effective term".
All prices are relative, so when someone talks about oil price, strictly speaking he has to be explicit whether it's in dollar, euro, or thai baht etc. Now as a convention, everything is priced in dollar terms in the real world (so euro, oil, gold etc are priced relative to dollar).
So my point is, if everyone suddenly hates dollar, probably because the US is entering the recession etc, then you'd expect all types of investors to sell dollar, and buy something else, e.g. other fiat money like euro, sterling, or even commodity money like gold and oil. The prices of euro and oil (relative to dollar, remember) will go up. Conversely, if everyone suddenly loves dollar, they will sell everything else, so the prices of euro and oil will drop. So I have created a scenario where euro and oil prices are positively correlated, only because of the dollar factor. There needs not be a direct causation from oil price to dollar, as the news article suggests.
'Effective measure' is an attempt to get an absolute measure of price, rather than a relative one. So if you want to know whether dollar is really getting weaker against 'everything', and not just euro,you'd have to look at dollar relative to everything, and gets an average somehow. We can use a weighted average, say attach more weight to euro because eurozone is a larger trading partner of US, for instance. Same thing with oil price...if oil is really getting more expensive because of its own supply-demand factors, then you'd expect oil to be more expensive across all currencies. A weighted average price will be a useful indicator of that.
Interesting to know.
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