When it comes to inflation and oil price trends, Canada and Japan are on opposite ends of the spectrum. On the one hand, Canada is a heavily oil-based economy with significant sensitivity to changes in oil prices. Intuitively, a rise in oil prices has benefits for Canada's oil industry and exports. Japan, on the other hand, is a nation whose currency is highly sensitive to inflation. Given inflation and oil prices go hand in hand, I started to investigate whether this could mean CAD (Canadian Dollar) appreciation against the JPY (Japanese Yen). In this article, I use regression analysis techniques to illustrate the relationships between the movements of the CAD/JPY, Brent Crude Oil Prices and the Japanese Consumer Price Index. In addition, I use technical analysis to further investigate possible directional shifts for the currency pair. Note that CAD is treated as the base currency and JPY is treated as the price currency.
I use two regression equations to attempt to build a predictive model of whether oil prices and Japanese inflation have a significant impact on the currency pair. I use the log-log model of regression analysis, i.e. I examine the growth rates in each variable (using the logarithmic function) on a monthly basis from January 2000 to present. The full regression output generated by the R Studio Statistical Package is available here.
(1) JPY/CAD = Intercept + β (Brent Crude Oil Prices) + β (Japanese Consumer Price Index)
(2) Japanese Consumer Price Index = Intercept + β (Brent Crude Oil Prices) + β (Japanese Consumer Price Index at t-3 months)
Regression 1 yielded the following output:
JPY/CAD = 0.0008234 + 0.0472962 (Brent Crude Oil Prices) + 0.7459180 (Japanese Consumer Price Index)
According to this regression, a 1% change in Brent Crude Oil Prices will cause a 0.047% change in the JPY/CAD. However, a 1% change in the Japanese Consumer Price Index will cause a 0.74% change in JPY/CAD. The regression results indicate that, according to our p-values, the X Variable for Brent Crude Oil prices is significant at the 10% level, but Japanese Consumer Price Index was found to be insignificant at the 10% level, meaning that the results for this variable are questionable. To further test the relationship between oil prices and Japanese inflation, I ran Regression 2 below using a three-month time lag to account for potential time differences between these two variable.
Regression 2 yielded the following output:
Japanese Consumer Price Index = -0.0001794 + 0.0065019 (Japanese Consumer Price Index at t-3 months) - 0.1650964 (Brent Crude Oil Prices)
According to this regression, a 1% change in the Brent Crude Oil Price is correlated with a -0.16% change in the Japanese Consumer Price Index. Notwithstanding that we have not attempted to correct serial correlation, our p-value is highly significant at 0.0174. Given that our regression has affirmed a negative relationship between these two variables, we cannot conclude that Brent Crude Oil Prices will cause inflationary pressures in Japan. In fact, the data would appear to confirm the opposite trend. In addition, our first regression has shown that oil prices by themselves have a negligible effect on the JPY/CAD pair. Both regressions tested positive for serial correlation, meaning that there is a pattern between the historical trends observed, i.e. they are more likely to repeat themselves in future. Note that this will affect our p-values and increase the chance of rejecting a true null hypothesis that our Beta is different from zero, so the results should be interpreted with caution.
Based on technical analysis factors, the 20-day moving average of JPY/CAD is currently trading below its 200-day moving average, and while we have seen a recent uptrend in the currency pair, low volatility appears to have led to a Bollinger Band "Squeeze", which indicates that we could see a movement in the opposite direction. Ultimately, whether the 20-day moving average breaches the 200-day moving average will be a big telling point as to whether the CAD is set to appreciate further.
In conclusion, while the current macroeconomic environment is one in which rising oil prices appear to play an ever-growing concern, there is no evidence that the CAD will appreciate against the JPY on this fact alone, and in many ways the evidence offered would even suggest the opposite. While there are a myriad of factors that could affect the currency pair, they are outside the scope of this article. JPY is traditionally known as a "safe haven" currency, and current macroeconomic factors would suggest that potentially lower risk appetite on the part of investors would not mean that CAD would appreciate as a result of higher oil prices.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.