Traders love correlations in markets, and it’s likely because correlations present an overly-simplified way to approach a market by looking at peripherals to get an idea for what might happen down the road. One example of this is the Canadian Dollar’s correlation with Oil. Canada is a big exporter of Oil, and this provides a significant portion of the industry in the Canadian economy. As the price of Oil goes up, this means more revenue which will then lead to increased investment back into the business, including in the form of more workers. As more workers in the Canadian economy get hired by an expanding energy industry and as competition heats up for those workers, wages rise and inflation picks up.

As inflation picks up, so do expectations for higher interest rates. This means stronger swap rates for those holding that currency long at rollover (this is called the carry trade, and if you’re anywhere around markets, you want to know what it is because this can be a significant driver of capital flows). To learn more about the carry trade, and to see a pretty fantastic example, take a look at my colleague Tyler Yell’s piece from 2012, and notice the rates from the time of publishing. This is back when USD/MXN was at 12.82… now we’re at 17.32, and that’s not the only prime example.

But the direct currency correlation with Oil prices isn’t the only impact here, right? Because there is that transmission effect that will often take a few months to filter into the economy, kind of like how it takes a few months for gas prices to come down after Oil prices have fallen. Those gas stations have inventory purchased at higher prices, and they don’t want to take the hit. So they have to churn through their more expensive inventory before being able to pass on that cost savings to their customers, in much the same way that lower oil prices will wreak havoc on energy companies that are forced to react to a changing environment.

All of that beautiful synergy that we discussed earlier, in which higher oil prices lead to wider margins, which leads to more investment and more hiring, eventually bringing on inflation and higher interest rates; ya, that whole thing is dead. Commodity prices are continuing to shoot lower at a breakneck pace. We’re going in the other direction right now, and that synergy can be just as painful on the way down as it was beneficial on the way up.

As oil prices fall, margins from energy companies get squeezed; and in many cases, at least right now with oil prices having fallen so far so fast, these companies aren’t even breaking even on producing a barrel of oil. Their cost structures are based on Oil prices at $80 or $100, and these companies can ill-afford to continue producing Crude at $35 or $40 a barrel. As this happens, as these margins get squeezed and as these companies see earnings evaporate into losses, they react; and they do so by cutting back on workers or reinvestment into the business (since they have no free cash flow to reinvest anyways). This leads to higher unemployment, and less competition in the job market which leads to less growth in wages; and perhaps even a contraction in wages.