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How The U.S. Dollar Influences Oil Prices

Fed Building

Crude oil has reached a critical technical level, which is likely to test the resolve of the bulls to push prices higher. The bulls have a favorable tailwind with production outages reducing the supply glut. Till about two weeks ago, the drop in the U.S. dollar was also supportive of the crude oil prices, but since then, the dollar has recovered, putting pressure on the crude oil prices.

The U.S. dollar and the various commodities have an inverse correlation. The chart below shows the correlation between crude and the U.S. dollar index for the past 12 years.

(Click to enlarge)

The chart shows a clear inverse correlation between the two, especially when there is a sustained trend. From 2003 to 2008, the dollar was in a sustained bear trend, during which, crude oil witnessed one of its strongest bull runs.

When the dollar formed a bottom, crude oil started its sharp decline, during the last financial crisis. Related: International Markets Prove Hard To Conquer For U.S. LNG

The dollar entered a range by the end of 2009. Crude rose till 2011 when the dollar came down to test its lows of the range, and since then, crude oil has remained in a range along with the dollar till mid-2014. During the range bound move, the correlation between the two is not perfect, as can be seen in the chart above.

Once the range was broken and a new bull trend started in the dollar, crude started tanking. The dollar, which was in a roaring bull market expecting a sharp rise in interest rates, has entered range bound trading, post FED clarification of a gradual rate hike.

Since the dollar entered a range bound move between 93 on the lower side and 100 on the upper side, crude has reacted to its own news and fundamentals rather than follow the dollar’s every move, as can be seen in the chart below.

(Click to enlarge)

Until the April FED policy meeting minutes were released on 18 May 2016, the market was under the impression that there will be no hike in the June meeting. In anticipation of no rate hikes, the dollar had dropped to the lower end of the trading range and threatened to break below, starting a new downtrend.

However, the minutes of the FED’s April policy meeting surprised many market participants for its hawkishness. The FED has kept the chances of a June rate hike on the cards. The dollar bulls latched on to the news and have pushed the dollar higher, away from the recent lows.

The dollar is still far away from breaking the range of the past 15 months. Hence, crude oil will not necessarily follow the dollar completely. And though it will react to any news affecting the dollar, these moves are expected to be short-lived.

(Click to enlarge)

Crude oil is entering an area of stiff resistance, as shown in the chart above. It has been a ‘V’ shaped recovery from the bottom, pushing the RSI into overbought territory. Hence, we expect crude oil to retrace from the current levels. However, if it manages to break above the resistance zone, the next target for crude is closer to $60 per barrel. Related: International Markets Prove Hard To Conquer For U.S. LNG

Nonetheless, June is packed with a number of important events, starting with the OPEC meeting on the 2nd, followed by the FED policy meeting on the 15th, and the Brexit referendum on the 23rd.

Among the three important events, the OPEC meeting is unlikely to reveal any surprises. However, the remaining two events can significantly move the U.S. dollar and crude oil.

Hence, along with concentrating on crude’s fundamentals, traders should keep an eye on the U.S. dollar as well.

By Rakesh Upadhyay for Oilprice.com

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