Oil prices and the U.S. dollar have been moving in the same direction for over a month—an unusual pattern considering the typical inverse relationship between the commodity and the greenback.
The positive correlation—with both the dollar and crude oil prices moving higher—is not so rare, but it sure isn't the usual inverse link that has been seen more often than not for decades.
The central banks and the central bank of crude oil supply, OPEC+, are responsible for the current positive correlation, which analysts expect to be short-lived as concerns about the economy would eventually bring back the inverse link between oil prices and the dollar.
The Inverse Link
Since oil is priced in dollars, a rising U.S. dollar typically leads to lower oil prices, while a weakening dollar tends to push crude higher. A stronger dollar means oil is more expensive for holders of other currencies, while a weak dollar helps other currency holders get more crude for their money. Effectively, a stronger dollar makes crude more costly for importers using currencies other than the dollar, which could lower demand for oil.
This typical inverse relationship was broken at the end of the summer due to the OPEC+ cuts, the extra voluntary Saudi production reduction, and the Fed's still rising interest rates, although the peak may be near.
The unusual positive correlation in the dollar-oil relation could be ending, as the expected economic slowdown or recessions in many developed economies could dent demand for crude and weigh down on oil prices, analysts say.
The Positive Correlation
Since early September, both the U.S. dollar and crude oil prices have been moving higher. The positive correlation reached on September 29 its highest since the middle of March, according to LSEG data compiled by Reuters.
The dollar rally was due to the interest rate hikes, while the OPEC+ supply cuts have tightened the market, and oil prices surged to one-year highs at the end of September.
Despite the crude oil price rally for most of September, Saudi Arabia and Russia, the key OPEC+ partners, said in early October that they would be keeping their oil supply cuts in November.
As the 'central bank' of oil supply, OPEC+ is influencing oil prices by restricting production and exports, although the official line from the cartel and its ally in these cuts, Russia, is "keeping "stability and balance on the oil markets."
The Near-Term Outlook
The oil market could further tighten in the coming months, but economic concerns and higher-for-longer interest rates could dampen demand for crude, analysts say.
Of course, the markets never stay calm for long, and the threat of a war in the Middle East returned this week. Chances of the Israel-Hamas war spreading to impact oil supply are currently assessed as low, but they are not entirely nonexistent.
The conflict could further support the dollar, analysts at ING say.
"At around three million barrels per day, Iran is proving to be this year's key marginal supplier of oil, and a further geopolitical risk premium could be built into crude should sanctions against Iranian crude be enforced more vigorously or any more direct form of response take place," they noted earlier this week.
"Away from developments in Israel, Friday delivered a very strong US jobs report which looks set to keep the Federal Reserve in hawkish mode for a little longer," ING's forex strategists said.
Other strategists noted this week early signs of exhaustion in the U.S. dollar strength.
"We have highlighted before that clear signs of deterioration in the US economy will be needed to reverse the dollar uptrend," Charu Chanana,
market strategist at Saxo Bank, wrote in a note on Tuesday.
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"But all we have got for now is the strong NFP report and a further uptick in geopolitical tensions. While that should have underpinned another leg of strength in the dollar, the message coming across from the price action is one of exhaustion."
Still, many analysts, including those at Saxo Bank, believe that the positive correlation between the dollar and high crude oil prices cannot last much longer—something has to give.
"I believe that ultimately, the strong dollar will depress demand," Tamas Varga at oil broker PVM told Reuters, commenting on the dollar-oil prices link.
After a brief one-day surge following this weekend's attack by Hamas on Israel, crude oil prices were down on Tuesday, Wednesday, and early Thursday.
"Oil is still looking very bullish on the potential supply risks that are stemming from both wars and over optimism that China is going to whatever it takes for them to meet their growth targets," Ed Moya, senior market analyst at OANDA, said on Tuesday.
"It seems, the oil market will remain tight or get even tighter as we head into the winter."
By Tsvetana Paraskova for Oilprice.com
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The inverse relationship between the dollar and global oil demand is explained by a deliberate manipulation of the value of the dollar. If the United States wants to force oil prices down or arrest fast-rising oil prices, it has two ways of doing it. One is to introduce oil withdrawn from the US petroleum reserve (SPR) to the market but this could hardly be used again as the SPR has virtually been depleted.
The other way is for the US to deliberately hike the interest rates to depress prices or for the Federal bank to hike them to control inflation. Either way it does slightly impact the demand for oil.
The positive link could continue as long as the demand for oil is strong and being buoyed by a tightening market and a rising Chinese economy. But this will start to taper off in coming years as the petro-yuan starts to account for an increasing share of the global oil trade.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert