Saudi, Russia supply cuts disrupt oil, US dollar relation

Nasdaq

LONDON – Saudi Arabia and Russia’s crude supply cuts in tandem with U.S. interest rate rises have disrupted oil’s tendency to move in the opposite direction to the U.S. dollar, although analysts say the darkening economic outlook will eventually restore the equation.

A strong dollar typically weighs on oil prices as it makes the commodity more expensive for holders of other currencies, dampening demand for crude.

The reason both have moved higher at the same time is because the U.S. has hiked interest rates to stem inflation while top OPEC+ oil producers Saudi Arabia and Russia have voluntarily cut production beyond OPEC+ agreements.

Oil prices in September hit 10-month highs as Saudi Arabia and Russia cut a combined 1.3 million barrels per day (bpd) of supply until the end of the year.

The dollar has strengthened in response to interest rate hikes, and investors have priced in expectations that rates will stay high for longer as central banks struggle to rein in inflation. Higher energy costs have contributed to those inflationary pressure in recent months.

While it is not uncommon for oil’s inverse relationship with the dollar to be temporarily disrupted, over the long term the inverse relationship has endured.

When Brent prices hit an all-time high of above $147 a barrel in early July 2008, the dollar was also moving in the same direction as crude, but the correlation was narrower than current levels, LSEG data shows.

Over the past two decades, the strongest period of correlation between the two has been in mid-2018 when rising Chinese demand was propelling prices.

STRONG CORRELATION

The greenback and Brent oil have been moving in the same direction since early September, and the positive correlation hit its highest since mid-March on 29 September.

Analysts expect the correlation will be short-lived.

“The dollar is very expensive and my macro forecasts for next year are fairly downbeat, with the U.S. joining other regions in recession,” said Colin Asher senior economist at Mizuho.

“Against that backdrop, I struggle to see how commodity prices can remain or continue to move higher.”

The link between the strong dollar and oil prices will likely only return to normal once the U.S. Federal Reserve changes its rhetoric into a more dovish stance – in that the fight against inflation has been won, and rate cuts can begin, added Francesco Pesole, FX strategist at ING, who anticipates U.S. rate cuts will come sometime in the first quarter of 2024.

The impact of rising oil prices on consumption typically depends on whether prices are demand or supply driven – they go up if demand is expected to eclipse supply or supply is seen to be in deficit in relation to demand, analysts and economists say.