The U.S. dollar, along with a variety of other factors, used to be an important component in deciding the direction of oil prices. This was true for the period between September 2007 and April 2013, when the one-month correlation between the U.S. dollar and crude oil was largely negative. In other words, whenever the U.S. dollar rallied, crude oil prices fell—and vice versa.
But this relationship has changed considerably in the last few years, prompted by the oversupply of oil.
Between April 2013 and January 2017, the one-month correlation between crude oil and the dollar swung wildly between -64 percent and 43 percent. During this period, the market was fixated more on OPEC’s actions and the response of the U.S. shale oil drillers than on the dollar.
If, however, one looks at the relative performance of the dollar and crude oil since the U.S. Presidential election, one finds a strong positive correlation.
The dollar rallied from an intraday low of $95.89 on November 09, 2016, to an intraday high of $103.82 on January 03, 2017, an impressive rally of 8.26 percent within two months. On the other hand, crude oil rallied from a low of $43.12 per barrel on November 09, 2016, to a high of $55.21 per barrel on January 03, 2017—a 28.03 percent rally.
The dollar’s rally was buoyed by Donald Trump’s victory in the U.S. Presidential elections. His campaign promises of tax cuts and increased fiscal spending boosted expectations of stronger growth and higher inflation. In response, the U.S. Federal Reserve was expected to tighten rates at a faster pace than previously envisaged.
Meanwhile, crude oil’s rally was boosted by OPEC and Russia’s decision to cut oil production, and while the dollar was indeed stronger, the crude oil rally had very little to do with the dollar.
Since reaching their highs in the first week of January, the dollar has been in a correction, whereas, crude oil has remained in a range.
Higher crude oil prices provided a new lease on life to the U.S. shale oil drillers who went about adding new rigs, and have now added oil rigs for five straight weeks. The oil rig count has increased from a six-year low of 316 in May 2016, to 597 in the week to February 17. As a result, U.S. oil production is expected to rise by nearly 79,000 barrels per day in March. Related: Oil & Gas M&A Just Broke All Records
While OPEC’s production cut has put a floor beneath crude oil prices, increased supply from U.S. shale oil companies has capped crude oil’s rally.
“Prices continue to be pulled between the contradictory influences of reports of falling OPEC production and rising U.S. crude inventories,” said David Martin, an analyst at JPMorgan Chase & Co. in London, reported Bloomberg.
The U.S. dollar, on the other hand, is showing signs of exhaustion. The recent sluggish performance of the dollar after the Fed Chair’s hawkish statement is being seen as an indication of further weakness to come.
"When the Fed chief says, pretty much unabashedly, that she's going to go to three rate hikes, and she sort of talks up the economy, and yet the market remains skeptical, that's telling me something," Schlossberg of BK Asset Management told CNBC.
Hence, looking at the past few months, though the positive correlation between the dollar and crude oil is high, both are being influenced by different factors. Until the excess supply issue is sorted out, it is unlikely that the U.S. dollar will have an overbearing effect on the prices of crude oil.
By Rakesh Upadhyay for Oilprice.com
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