5 Apr

Can the US Dollar Limit Oil’s Upside?

WRITTEN BY Rabindra Samanta

Crude oil and the US dollar index

US crude oil (DBO) (USL) (OIIL) futures contracts for May delivery rose 5.5% between March 28, 2017, and April 4, 2017. The US Dollar Index (UUP) (USDU) (UDN) rose 0.9% during that period.

Can the US Dollar Limit Oil’s Upside?

In the past five trading sessions, crude oil and the US dollar moved in opposite directions in only two instances. The correlation between crude oil and the US dollar in the past five trading sessions was 41.1%, which doesn’t show an inverse relationship between the US dollar and oil prices during that brief period.

However, 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. In the trailing week, crude oil rose even as the US Dollar Index gained.

The Fed hiked interest rates on March 15, 2017. It might hike interest rates two more times by the end of the year. Rising rates could boost the dollar and pressure crude oil prices.

Long-term correlation between crude oil 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 the present, the correlation between crude oil and the US dollar has been more bidirectional. During that period, the one-month correlations fluctuated between -64.0% and 43.0%.

The correlations during that 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

The Trump Administration’s energy and climate policies could mean increased crude oil, natural gas, and coal production in the US, which could mean lower crude oil prices. While fundamental factors dominate, the US dollar’s impact on crude oil prices could be limited in the long term. Global crude oil demand could 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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