Why Oil Prices Are Bothering the AUD

October 14, 2016

Image result for oil aud

Evdokia Pitsillidou, Director of Risk Management, easyMarkets

Historically, there hasn’t been much of a strong correlation between crude oil and the Australian dollar, whether it’s a positive or negative. These days, however, the rise in the commodity seems to be accompanied by a drag on the Australian currency.

Speculative positioning updates from the Commodity Futures Trading Commission revealed that traders are being less bullish on the Australian dollar in the past few weeks, even as the Reserve Bank of Australia opted to keep monetary policy unchanged even with its shift in leadership. The Australian central bank maintained a relatively neutral tone, leading market watchers to predict that they could keep interest rates on hold for much longer.

Meanwhile, investors are being more bullish on crude oil after the informal OPEC meeting in Algiers last month strengthened the resolve of the bloc to stabilize the markets. Saudi Arabia’s energy minister that the conditions are looking brighter for an output deal this time, although they are still debating on the specific production levels per country.

Still, this was enough to drive the commodity higher in the past few weeks, getting another boost recently after Russian President Vladimir Putin indicated that they’re also willing to participate in an output freeze or cap if the OPEC decides to impose one. WTI crude oil is trading past the $51 per barrel level while Brent crude oil has advanced above $53 per barrel as of this writing.

In contrast, the Australian dollar has tumbled so far this week, dropping from a high of .7628 on Monday to test .7550. AUDJPY has retreated below 78.50 and AUDCAD is back below parity. Are the crude oil rallies weighing on the Aussie’s gains?

For one, the pickup in crude oil price has driven more money flows to this sector and away from other commodities such as gold. This has weighed on the precious metal’s price and on the positively-correlated Aussie as well. Prospects of a recovery in the energy sector could attract more investments in U.S. shale oil companies and Canada’s energy industry, causing outflows from similar industries such as mining.

Apart from that, comdoll traders who are pursuing riskier currencies for their higher yields likely moved their funds from long AUD positions to long CAD positions, especially as traders anticipate more developments for the upcoming informal gathering of OPEC leaders in Istanbul this week.

Besides, a longer-term climb in oil prices would translate to higher energy costs, which could dampen profitability for manufacturing companies. This would make it more challenging for Australia to shift to a non-mining investment-driven growth in the near term. Higher fuel costs could also dampen business production in China, which is Australia’s largest trade partner. However, these roadblocks could soon be overcome if the pickup in commodities eventually leads to stronger inflation.

For now, some analysts are saying that an oil production cut is actually possible, keeping crude oil supported until the next official OPEC meeting in November 30.

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