What's Next For The Tighter Link Between Oil And EM FX? - Goldman Sachs

The EM FX implications of a volatile and trendless 2016H1 oil market Our Energy team has argued that, over the first half of 2016 and potentially beyond, the oil market will feature rising volatility over a relatively stable and low price level: a volatile and trendless market produced by a painful re-balancing of supply and demand

What would such a market imply for EM FX? While Exhibit 3 appears to suggest that higher volatility would mean an even-larger day-to-day role for oil in EM currencies, Exhibit 4 provides some cautionary context. This exhibit is simply a more complete view of Exhibit 3, and sheds light on another volatile and trendless period in the oil market: the early 2000s. Between the fall of 1997 and the summer of 2003, for example, the oil market featured a low price, high volatility and an unclear trend, as the price of Brent crude fluctuated between $10 and $35. However, Exhibit 4 shows that, during this period, daily percentage changes in the global oil price played only a minor role in EM FX.

We suggest that the key difference between the early 2000s and today lies in how oil price fluctuations are interpreted by the market. Given the dramatic 60% fall in the global oil price during the summer of 2014, it is natural that the market is closely focused on each daily movement in the oil price. This also suggests that, in a volatile and trendless oil market in 2016H1, it may take some time before this effect 'wears off.

Finally, the importance of the oil price for EM currencies going forward will also depend on the extent to which countries continue to allow their currencies to respond to terms-of-trade shocks. Exhibit 1, for example, indicates that the sensitivity of the RUB to the oil price has recently increased, which is likely attributable, in part, to the recent liberalization of its currency.