A week ago, I asked how much further the dollar could run.
The greenback was riding an eight-week winning streak, and although I suggested it might be due for a breather, I also conceded there was ample scope for additional gains.
Although Bloomberg’s dollar index snapped the streak, the DXY kept on going. The dollar’s now one good week away from the best levels since November, when a cool CPI report triggered a big pullback.
The euro, meanwhile, fell a ninth week (no) thanks to a very rough ECB day.
It’s easy enough to explain dollar strength by way of forward policy expectations and US economic exceptionalism. Here’s Goldman’s Kamakshya Trivedi:
The contrast between the Fed and ECB in this forecasting round offers an important lesson for FX investors. The ECB revised its headline inflation forecasts up despite taking the growth forecasts down. Fed officials will likely do the opposite this week — revising inflation down despite much stronger growth. The key tactical question will be how durable FOMC officials think this trend can be. As the market reaction to the ECB demonstrated, FX markets focus primarily on the distribution of the forward policy profile. We think Fed officials will likely not be able to firmly close the door on further hikes or credibly open the possibility of imminent cuts just yet, which would probably lend further support to the recent dollar trend. But, taking a step back, the pattern of these revisions represent opposing supply-side news, and that is what has underpinned the structural support for the dollar. We have consistently argued that for the dollar to decline it will require better capital return prospects abroad, and that does not appear imminent.
It’s hard to argue with that, and there’s no reason to — it’s correct. And it goes a long way towards explaining recent dollar strength.
That said, the dollar’s also an oil story now, and not in the way many market participants traditionally thought about the relationship.
As discussed here on several occasions over the past month or so, the greenback now has a positive correlation with crude. This isn’t entirely “new,” but it’s grabbing more headlines as time goes on.
The “unusual co-movement,” as the BIS called it, is a problem for consumers outside the US. Oil’s denominated in dollars, so if your currency is depreciating against the dollar, the impact of a concurrent oil rally is amplified.
“The change in the commodity price-dollar nexus implies that movements in the US dollar now compound the effect of commodity prices changes on the global economy,” the BIS said, in a recent bulletin. “Commodity price rises tend to stoke inflation and choke off growth in commodity-importing economies, while dollar appreciation tends to do the same outside the US.”
It’s possible that in their desperation to defend flagging currencies, Asian importers could resort to Treasury sales, limiting the scope of any long-end Treasury rally. When considered with a persistently strong dollar, stubbornly high long-end US yields are a financial conditions tightening impulse.
There are several obvious reasons for the dollar-oil co-movement. The US is a net energy exporter now, recent energy shocks were associated with risk-off events which tend to be dollar bullish and in an inflationary environment, market participants will be inclined to view rising commodity prices as a hawkish risk for the Fed.
If the dollar’s a commodity currency now, the constellation of dollar-bearish macro-market conjunctures is diminished. And generally speaking, a persistently strong dollar makes for an onerous environment, almost across the board. On the bright side, it’s advantageous for a Fed concerned about inflation, and worried that rising oil prices might undercut that fight.
As Barry Knapp put it last week, both on CNBC and Bloomberg, “The dollar now is a petrocurrency.”
