22 Mar

How Oil Prices Might React to More Rate Hikes

WRITTEN BY Rabindra Samanta

Crude oil and the US dollar index

US crude oil (DBO) (USL) (OIIL) futures contracts for May delivery fell 0.2% between March 14, 2017, and March 21, 2017. The US Dollar Index (UUP) (USDU) (UDN) fell 1.9% during that period.

How Oil Prices Might React to More Rate Hikes

In the past five trading sessions, crude oil and the US dollar moved in opposite directions in three instances. The correlation between crude oil and the US dollar in the past five trading sessions was -56.5%, which shows an inverse relationship between the US dollar and oil prices over this brief period.

Remember, a stronger dollar makes crude oil more expensive for oil importers, which has a negative impact on prices. If the dollar strengthens, it could pressure crude oil prices. The Fed hiked interest rates on March 15, 2017, and may raise them two more times by the end of the year. Rising rates could boost the dollar and consequently pressure crude oil prices.

The long-term correlation between crude and the dollar

Between September 2007 and May 2013, the one-month correlation between crude oil and the US dollar was positive in only a few instances. The correlation was largely negative during that period.

However, from May 2013 to now, crude oil and the US dollar’s one-month correlations have been more bidirectional. Between May 2013 and March 2017, the one-month correlations fluctuated between -64.0% and 43.0%.

The correlations during this period could mean that the following fundamental drivers sometimes had a greater impact on crude oil than the US dollar:

  • Saudi Arabia’s production decisions
  • US shale oil producers’ cost and production dynamics
  • OPEC (Organization of the Petroleum Exporting Countries) and non-OPEC production and supply data
  • US inventory data
  • rig count data
  • other news regarding fundamentals

To be clear, the Trump administration’s energy policy could mean increased crude oil, natural gas, and coal production in the US, but it could also have a negative impact on crude oil prices. And while fundamental factors dominate, the US dollar’s impact on crude oil prices could be limited in the long term. However, global demand could still be the biggest driver of crude oil prices in the long term.

ETFs and crude oil

ETFs such as the Direxion Daily Energy Bear 3X ETF (ERY), the First Trust Energy AlphaDEX ETF (FXN), the United States Brent Oil ETF (BNO), the Direxion Daily S&P Oil & Gas Exploration & Production Bear 3x ETF (DRIP), and the United States Oil ETF (USO) are also impacted by movements in crude oil.

In the next part, we’ll look at the relationship between crude oil prices and the futures forward curve.

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