Oil at war with the US dollar

China

“Rising oil pricing and surging imports from China lead to a significant deterioration of America’s trade balances, which in turn led to a weakening US$. At the same time, dollar weakness contributed to a spike in oil prices to US$147/bbl in 2008, ultimately helping trigger the global financial crisis.”

“The energy sector has led a firm recovery in economic activity in the US in the last five years, first by reducing America’s dependency on foreign oil barrels and then by driving a collapse in global energy prices and thus a major reduction in the US oil import bill. Simultaneously, China’s economy has shown clear signs of a natural slowdown after years of fast growth, particularly as it relates to its commodity intensive industrial and power generation sectors.”

Europe

“Economic growth expectations for Europe are likely to remain rather muted by comparison to fast growing Emerging Markets. But the crucial point is that an improving economic outlook in Europe at the expense of a weaker Euro is unlikely to lead to a major commodity bull run…a recovery in the US and Europe may help fuel growth in the emerging world, but not before developing economies have adjusted to the new reality of higher US interest rates.”

Pushing prices

“Are currencies driving commodity prices, or is the collapse in the commodity complex driving the US$ stronger?”

“Oil is the largest commodity produced by the world, and by far the largest commodity traded among nations. A small group of countries produces the bulk of it while every country uses oil…changes in oil prices tend to move trade balances of most countries more than say, changes in coal, iron ore or soybean prices.”

Relationships

“For oil, the relationship between the commodity and the currency is not straightforward. To start with, there is no clear lead-lag relationship across major oil consumer currencies and oil price.”

“We find that oil generally Granger Causes currency moves across major oil producing countries. Hence, the recent collapse in oil prices has had a meaningful effect on currents in the last few months. Put differently, the oil market imbalance requires curbing US shale production growth. In turn, the US$ is strengthening against the currencies of oil producing countries, pushing shale producers up in the global oil cost curve.”

“The US trade balance has benefitted significantly from the decline in oil prices, likely lending support to the US$ in the past six months. But the drop in oil prices has arguably had an even more beneficial effect on Europe and Japan due to their larger foreign oil dependency. Moreover, the race to US energy independence may have been postponed by a few years due to the drop in oil prices, arguably having a negative effect on the economy in the medium term.”

“Yet, monetary policy divergence may in turn be exacerbating the downward move in oil prices by lowering the equilibrium price of oil for the world.”

India

“It is worthwhile pointing out that the lower oil prices have brought India’s trade balance into rude health, at least relative to previous years. The oil trade deficit in India is still running at approximately US$50 billion/y or about 2 – 3% of GDP, a manageable figure.

Price recovery

“This combination of a stronger dollar, a slowing China, and falling commodity prices is not going away anytime soon…As such, we expect commodity exporters in the emerging world to remain under pressure.”

Edited from report by Claira Lloyd

Published on 07/04/2015


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