Wednesday, August 20, 2014

US dollar up across the board | Crude Oil as a leading indicator

Over the last three days the US dollar has been on fire. The rising strength of the Greenback is in evidence against all its major counterparts, EURUSD, USDCAD, USDJPY, GBPUSD, AUDUSD and so on.

The rise is broad and deep. It started well in advance of the release of the Federal Open Market Committee (FOMC) minutes for its July 29 – 30th meeting, which were released late last evening in GMT terms. It then seemed to pause, while market participants parsed the comments of the members of the Committee and came up with the view that, yes, there does seem to be a change in sentiment with regard to the imminence of US rate rises. In fact the major discussion has now seemingly moved to the question of how, rather than when, a regime of base rate rises Stateside can be implemented.

Crude Oil as a leading indicator

For some time now also, crude oil prices have been dropping, quietly but with conviction. That this is happening in the face of some well publicised geopolitical tensions, many of them connected with oil producing parts of the world, is particularly significant.

In the past, the price of oil has always been inversely correlated with the value of the Greenback on the global stage. This is because, wherever it is bought, oil is priced in US dollars. Therefore, when parties in non-US regions wish to purchase the black gold, they must change their own currencies into the US unit. This creates the linkage between the two.

It therefore becomes a question of which is the driver of the current situation – does an increase in production, for example as a result of the widespread use of the fracking method of extracting shale oil and gas in the US and a consequent greater flow onto the world market, decrease the oil price and thereby strengthen the dollar, or does inherent dollar strength allow for a reduction in the price that must be gained for it economically, and send this most basic of hard commodities lower?

Or have we something in the nature of a virtuous cycle, where first one and then the other comes into play and reinforces the move to a more normal, in historical terms, oil price and US dollar value?

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