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The US dollar (DX-Y.NYB) is currently caught in a tug-of-war between oil prices and the Federal Reserve, Rabobank senior FX strategist Jane Foley pointed out in a note to clients on Thursday.
It began when the dollar’s old relationship with oil started breaking down.
Historically, crude oil (CL=F, BZ=F) and the greenback have moved in opposite directions. Oil is priced in dollars, so a stronger currency weighs on the commodity because it costs buyers more to purchase it.
That relationship began to shift in 2022, when Russia invaded Ukraine and the US cemented its position as a major energy exporter, Foley stated. That shift became more significant as the war in Iran disrupted shipping through the Strait of Hormuz.
Higher oil prices once represented an almost unambiguously negative shock for the US economy. But the war in Iran — which has triggered the largest energy supply crisis in history — has presented an opportunity for major US oil producers to ramp up production and take advantage of higher prices, bolstering the country’s energy exports.
The American energy boom has also put the US in a markedly different position from other major economies. The eurozone, for example, remains a major energy importer, leaving it more exposed to a combination of higher inflation and weaker economic growth.
That divergence has helped reinforce the dollar’s traditional safe-haven appeal since the conflict began, Foley said.
At the start of the war, the market’s positioning was short the US dollar, a stance that “reflected the then consensus expectation that the Fed was likely to cut rates this year coupled with the hang-over from last year’s heightened debate about de-dollarisation and the structural outlook for the greenback,” Foley said.
According to Foley, the rush to unwind those bearish bets likely amplified the dollar’s initial rally when the war broke out.
“For as long as shipping through the Strait of Hormuz is curtailed, the USD is likely to retain a safe haven premium, supported by the US’s energy exporter status,” Foley wrote.
There is, however, a competing force acting on the greenback: the Federal Reserve. A much softer-than-expected July payrolls report and relatively benign July inflation data have pushed investors to pare back expectations for rate hikes, removing a key source of dollar support.
Data from the Bureau of Labor Statistics’ Consumer Price Index (CPI) and Producer Price Index (PPI) releases this week have shown consumer and wholesale inflation growing at a slightly slower pace than expected.
