As the oil price hits all-time highs against the euro and sterling, investors are starting to worry about the knock-on effect on their currency portfolios.
The price of Brent crude has risen more than 12 per cent in the past month to reach $124.50 a barrel, amid rising tension between the west and Iran over its nuclear programme. The planned introduction of European sanctions and Iranian threats to cut off supplies have fuelled the gain in prices.
Currency analysts are poring over portfolios to predict the effect of an oil supply shock, in response to concerns from clients in recent weeks.
“Lots of clients have been asking about Iran,” says John Normand, head of currency strategy at JPMorgan. “A recurring question is how to hedge Middle East tension in currencies.”
Many are recommending that those concerned about oil price volatility move into currencies of countries that are oil exporters and which are regarded as havens at times of crisis.
The choice of an oil hedge in the currency market is limited, with much of the world’s oil production coming from countries that do not have free-floating currencies, such as Saudi Arabia.
That makes oil-producing currencies from countries with liquid markets obvious choices, analysts say.
The Norwegian krone, the “Nokkie”, which hit a nine-year high against the euro this week, and the Canadian dollar, are top of many investment banks’ lists.
“In a supply side squeeze you want less risky currencies that have oil and the Norwegian krone is a fantastic example of that,” says David Bloom, currency analyst at HSBC.
Simon Derrick, currency analyst at BNY Mellon, says the Canadian dollar has historically performed well at times of high oil prices. Canada’s trade links with the recovering US and its relative political stability also make it a natural haven choice, he argues.
One of the most popular currencies to short in an oil hedge is the yen. Japan is the third-largest importer of oil in the world and has the largest oil deficit of the liquid G10 currencies. Indeed, the Nokkie is the best performing big currency in the past month against the apanese yen.
But analysts are divided over the performance of the yen in the event of an oil shock. Anything that creates global risk aversion is likely to see Japan’s sizeable army of domestic investors repatriate assets. Alan Ruskin, currency analyst at Deutsche Bank, believes that will trump any short-term impact from rising import prices.
Instead, he recommends buying currencies of countries that have an oil surplus against those in emerging markets with an oil deficit.
There are just five major countries that export more oil than they import: Russia, Norway, Malaysia, Canada and Mexico. Those with the largest oil deficit include Thailand, Hungary and Israel.
Taking long positions in the ruble against the forint, or the Malaysian ringgit against the Thai baht, are among the trades Deutsche Bank is recommending to its clients.
However, an oil hedge in the currency markets may only work for so long. Currencies remain susceptible to “risk on, risk off” trading, and with any economic recovery still in its infancy, an oil shock could see a flight into the dollar and a slump in growth currencies.
In fact, the effect that a higher oil price has on currency markets depends on the reason the price is going up. If it is due to rising demand, commodity currencies in emerging markets, such as Brazil or Russia, tend to outperform as they also benefit from increased risk appetite.
If, however, oil prices are rising due to concerns over supply, as in recent weeks, investors focus on oil exporters from economies seen as more stable.
That is one reason why some analysts are more cautious of recommending the Russian ruble or the Brazilian real, currencies of oil exporters but more susceptible to risk aversion.
Mr Normand believes that if the oil price rises above $130 a barrel, that will lead the krone and the ruble – his favoured currencies for hedging against the oil price – to give up their gains. In that scenario, he says the US dollar will outperform as investors take risk off the table.
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