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How a Fed Rate Hike Could Hurt Crude Oil Prices

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Federal Reserve meeting

The US Dollar Index (DXY) has risen 8% against global currencies in 2015. DXY has risen due to the speculation of an interest rate hike by the Federal Reserve. The next Federal Reserve meeting is scheduled for tomorrow. Market surveys project that the Fed will raise interest rates marginally in the December meeting. In 2016, we may see multiple interest rate hikes due to robust US jobs data and an improving US economic activity. Meanwhile, crude oil prices have fallen more than 30% in 2015 due to oversupply concerns. Record production from the United States to Russia has weighed on crude oil prices.

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US dollar and crude oil relationship 

Crude oil is a dollar-denominated global commodity. Appreciation of the US dollar makes crude oil expensive for oil-importing nations, and vice versa.

Lifting of the US oil export ban could benefit US oil producers due to narrowing of the spread between WTI (West Texas Intermediate) crude oil (the US benchmark) and Brent crude oil (the global benchmark), as discussed in the previous part of this series. However, the strong dollar will affect US oil producers who are willing to export, such as ConocoPhillips (COP), Continental Resources (CLR), Hess Corporation (HES), and Pioneer Natural Resources (PXD).

The rising dollar should curb demand for US crude oil, as it would make oil expensive for oil importers in their local currency. Also, US producers’ margins are affected by the volatile US dollar. The volatility in the market also affects ETFs like the United States Oil Fund LP (USO) and the iShares US Oil Equipment & Services ETF (IEZ).

US dollar perspective

The European Central Bank and economies like China, Japan, and India are easing their monetary policy. In contrast, the US Federal Reserve is tightening its monetary policy. Diverging monetary policies would make the dollar an attractive investment tool.

The improving US economy and funds flowing into the US market from the emerging market should also strengthen the dollar. The rising dollar should put further pressure on the pessimistic oil market. However, profit booking could drag the US dollar lower in the short term.

Read the next part of this series to learn how Saudi Arabia could ruin the global oil market.

 

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