Oil-Dollar Links

Sept. 21 (Bloomberg) — Oil is up, the dollar down; and if the petroleum part of the relationship doesn’t change significantly, which looks unlikely, nor probably will the currency piece.
For three decades, the correlation between two of the world’s most important prices was strongly positive, with oil and the dollar rising and falling in tandem.
Petroleum is bought and sold in dollars. That meant that as oil prices climbed, so did the global demand for dollars. The appetite for dollars increased further during recurrent oil shocks, as rising risk-aversion prompted investors to seek safety in U.S. Treasury securities. The U.S. currency was also buoyed by oil exporters’ propensity to both invest their export proceeds in dollar-denominated securities; and when they spent the funds on goods, they usually bought American.
Since early 2002, however, the correlation between oil and the dollar has been negative. When oil rises, the U.S. currency falls.
From about $19 a barrel in late January 2002, the price of oil has catapulted to $82.25. Over the same period, the dollar has tumbled 39 percent to $1.4045 to the euro and 33 percent on a trade-weighted basis.
After the Federal Reserve on Sept. 18 cut its federal funds rate by half a percentage point to 4.75 percent, crude oil rose to a record $82.51 a barrel.
“Oil exporters’ propensity to import from the U.S. has declined in recent years, while their tendency to import from Europe and Asia has risen steadily,” says Stephen Jen, global head of currency research for Morgan Stanley in London. OPEC nations currently buy more than three times as much from the European Union as from the U.S., he says.
To the extent that oil exporters keep buying European, Europe’s economy may be less affected by higher oil prices than the U.S. economy, prompting investors to favor European investments. And since oil imports account for about a third of the U.S. trade deficit, “high and rising oil prices may be particularly bad for the dollar,” Jen says. What’s more, many investors see the Fed reacting to rising oil prices by cutting interest rates to preserve growth and the European Central Bank by raising rates to ward off inflation.
Since the start of 1993, the dollar has been the worst performer among the world’s 10 major currencies when oil-price growth is stronger than usual, Paul Robinson, foreign exchange strategist at Barclays Capital says. Goldman Sachs Group Inc. this week raised its year-end oil-price forecast to $85 a barrel. The firm’s commodity analysts had previously projected $72.
That isn’t good news for the dollar.