Crude and dollar correlation: Why oil and the USD move in different directions?
By Angela Barnes and Piero Cingari
13:24, 15 December 2022
Oil prices fell in early trade on Thursday as the dollar (USD) strengthened after the Federal Reserve Chair, Jerome Powell, announced on Wednesday that the US central bank will raise interest rates further in 2023.
Brent crude oil price chart
His comments further heightened economic growth concerns among traders, mindful of how it could weigh on demand.
What is your sentiment on Oil - Brent?
US crude oil (WTI) price chart
At the time of writing, Brent crude futures fell 0.8% to $82.06 per barrel, while US crude futures slid 0.9% to $76.55.
Meanwhile, the dollar gained, which subsequently weakens oil demand as it makes the commodity more expensive for those holding other currencies to buy it.
GBP/USD price chart
Correlation between oil prices and the USD
Piero Cingari, market specialist at Capital.com, explained the correlation between crude and the USD.
“The relationship between oil and the US dollar is often negative, meaning that a strengthening of the dollar typically results in a decrease in oil prices and vice versa.
“The so-called petrodollar system, which came into existence at the end of the 1970s when the US and Saudi Arabia decided to adopt US dollars for oil transactions, explains the rationale for the negative oil-dollar link.
“Nations that import oil pay for it in USD, while those who export oil receive payment in the greenback,” Cingari said.
The market specialist further highlighted that, on the other hand, when the value of the US dollar falls, it becomes relatively more affordable to purchase oil, which in turn drives up crude prices.
“At the same time, when the Fed loosens monetary policy, it usually does so to stimulate growth, which boosts oil prices.
“The chart below depicts the US dollar index (DXY) in green on the left, and oil prices in black on the right scale. The long-term correlation (1-year rolling) between the dollar and oil prices is shown by the blue area in the pane below the price chart. As we can see, periods of negative oil-dollar correlation are more common and typically stronger than those of positive correlation,” Cingari said.
“The historical negative correlation between oil and the dollar, however, has substantially lessened when looking over the last two years since there have also been times when the two have exhibited a positive association, which is where they are now,” Cingari highlighted.
He said there were additional factors at play.
“Oil prices recovered significantly from extremely depressed levels in 2020 as the world reopened after the pandemic, while the dollar also strengthened as inflation rose, forcing the Fed to raise interest rates rapidly. The war in Ukraine led to a further spike in oil prices, while a risk-off in markets generated a rush to the safe-haven greenback.
“Subsequently, oil prices have been steadily declining since the end of Q2 2022, despite a weakening US dollar. This is most likely due to the fact that oil has been impacted by negative demand factors (China lockdowns) and continued SPR sales from the US, while the USD has fallen as other central banks followed suit by rising interest rates and US inflation has begun to fall,” Cingari said.
China aims for energy deals in Yuan over USD
Meanwhile, China is aiming to buy natural gas and crude oil from the Arabian Gulf using its own currency, the yuan (CNH), instead of paying in USD.
The plans for it were unveiled by China’s President Xi Jinping at a summit held in Riyadh on Friday, where he also reiterated China’s intention to continue purchasing large commodity quantities from Saudi Arabia.
However, no official announcements have yet been made by the Saudi royal family on if the offer to buy oil with yuan will be accepted.
Markets in this article
Related topics