US Dollar - Oil Correlation Unveiled

While it is difficult to establish statistical evidence of causality, we believe that the USD and oil will likely remain negatively correlated, for various reasons. Oil prices, therefore, will remain an important – though not the only – consideration for the dollar. Specifically, lower and stable oil prices should be positive for the USD, while rising oil prices should be negative for the USD. The circle of rising oil prices and a falling dollar was vicious. In contrast, the recent reversal of these trends is virtuous and, all else equal, positive for the world. Not only will lower oil prices help to support global demand, they should also permit greater monetary flexibility to deal with lower economic growth. (There are two aspects of the nexus between oil and the dollar: their correlation and the direction of causality. We have conducted Granger Causality tests, and found that, in practice, and for the most recent period (1992-2008), the dollar tends to lead oil, rather than the other way around.) Until around 2003, higher oil prices were correlated with a stronger dollar. This was primarily because petrodollars were not only recycled back in to the US through trade but also because of financial flows: the US was dominant in every way back then, in terms of the attractiveness of its exports and assets. However, since 2004, this correlation has evaporated, and since 2006, the correlation has turned intensely negative.

[I]Stephen Roach, Head Economist, Morgan Stanley[/I]

[B]Weekly Bank Research Center 08-25-08[/B]

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[B][B][B][B][B] On the Link between the Dollar and Oil [/B][/B][/B][/B][/B]

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[I] Stephen Roach, Head Economist, Morgan Stanley [/I]

While it is difficult to establish statistical evidence of causality, we believe  that the USD and oil will likely remain negatively correlated, for various  reasons.  Oil prices, therefore, will remain an important – though not the only  – consideration for the dollar.  Specifically, lower and stable oil prices  should be positive for the USD, while rising oil prices should be negative for  the USD. The circle of rising oil prices and a falling dollar was vicious.  In  contrast, the recent reversal of these trends is virtuous and, all else equal,  positive for the world.  Not only will lower oil prices help to support global  demand, they should also permit greater monetary flexibility to deal with lower  economic growth. (There are two aspects of the nexus between oil and the dollar:  their correlation and the direction of causality.  We have conducted Granger  Causality tests, and found that, in practice, and for the most recent period  (1992-2008), the dollar tends to lead oil, rather than the other way around.) Until around 2003, higher oil prices were correlated with a stronger dollar.   This was primarily because petrodollars were not only recycled back in to the US  through trade but also because of financial flows: the US was dominant in every  way back then, in terms of the attractiveness of its exports and assets.   However, since 2004, this correlation has evaporated, and since 2006, the  correlation has turned intensely negative.  

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[B] Just How Divided is the FOMC? [/B]

[/B] [/B] [/B] <em> Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

                                                                                                                                                                        The divide in the Federal Open Markets Committee (FOMC) seems to have closed up  somewhat in recent weeks, due probably to the drop in commodity prices helping  to reassure the hawks on the committee. At the latest meeting on 5 August, only  one member (Dallas Fed president Richard Fisher) voted for a rate increase,  although it was feared that others would follow suit. The most inveterate hawks  on the FOMC have softened their rhetoric slightly in recent weeks and are no  longer talking about the need for an immediate rate increase, settling instead  for a warning that a hike could come sooner than the market expects. The minutes  of the FOMC meeting on 5 August will be released on Tuesday night, and it will  be interesting to see how much disagreement there was between the hawks and the  doves on the committee. Before then we will gain an insight into what the Fed  believes to be the most important topics in the US economy right now, as this  weekend brings the Fed's annual symposium at Jackson Hole. Ben Bernanke will  talk about financial stability on Friday afternoon, and it will be interesting  to see if he touches on the turmoil surrounding the two big mortgage lenders  Fanny Mae and Freddie Mac, which flared up again during the week. An article in  Barron's focused sharply on the two GSEs' problems in raising sufficient capital  to counter the losses they face as a result of the downturn in the US housing  market. The renewed turmoil caused the two lenders' share prices to virtually  halve in the last week, and the yield on their mortgage bonds has risen further.  The drastic drop in share price will make it hard for the two to raise capital  through share issues, and the market is speculating about an imminent government  takeover of the two institutions.                                                                                                

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[B] Interest Rate Inertia: No Easy Out for Credit Adjustment [/B]

[/B] [/B] [/B] [I] E. Silvia, Ph.D. Chief Economist, Wachovia[/I]

                                                                                                                                                                        Sub-par economic growth combined with modest upward inflation pressures suggest  the Fed is keeping the benchmark funds rate on hold. There is no easy out for  creditors or debtors in our outlook. Short-term rates are likely to remain  steady as the Federal Reserve faces the dual imbalance of a slow growth economy  along with above-target inflation. Meanwhile credit availability, as measured by  the Fed’s own Senior Loan Officer Survey, is being rapidly reduced. For the  second half of this year we expect average real growth around 1.6 percent with  weakness centered in the domestic economy – consumption and business investment.  While inflation, as measured by the core PCE deflator, remains above the top end  of the Federal Reserve’s target range. As for long rates we expect the ten-year  rate in a tight 3.8 – 4.0 percent range. Yet there is significant uncertainty on  both the dollar and federal deficit outlook that suggests that rates could rise  above our outlook.                                                                                                      

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[B][B][B][B][B] Canada On The Edge of a Technical Recession [/B][/B][/B][/B][/B]

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[I] Steve Chan, Economist, TD Bank Financial Group [/I]

First, what to make of the risk that real GDP declined further in Q2? After  losing much of its shine late in 2007 and then contracting by a slight 0.3%  (annualized) in Q1, Canadian real GDP is expected to have grown in Q2, but just  barely. Since our June forecast for a mere 0.4% gain and the Bank of Canada’s  (BoC) modest July forecast of 0.8%, the data have lined up well enough against  both these forecasts to keep a 0-1% outcome as the most likely. Taken together,  the last pieces of economic data before next week’s release of the Q2 GDP  figures did not do much to pin down whether growth in that quarter was slightly  positive or slightly negative. They did, however, help to reduce the possibility  of an outcome significantly off forecast, meaning Q2 real GDP growth outside the  (-1.0, +1.0) range. While wholesalers finished Q2 with a good 1.0% monthly  increase in June sales volumes, retailers had a harder time of it and recorded a  0.4% decline in their sales volumes during the same month. Many retailers’  overall receipts were boosted by higher prices, mostly at gasoline stations, but  after stripping out price changes (which do not feed into calculations of real  GDP), it becomes apparent that the retail story unfolding is one of less bang  for your buck from a consumer’s standpoint. Some retailers are able to offset  lower volumes with higher prices, but times aren’t rosy for the many that  cannot, because of competitive pressures and/or weaker demand.                                                                      

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[B][B][B][B][B] Oil Price Fall to Boost Global Growth in 2009? [/B][/B][/B][/B][/B]

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[I] Trevor Williams, Chief Economist at Lloyds TSB Financial Markets [/I]

Oil prices have fallen back quite sharply from a peak of close to $150 a barrel  just a month ago to around $112 presently. But in real terms (adjusted for price  inflation) oil prices have risen in the last five years to exceed the peak  levels of the oil-induced economic crisis of the late 1970s, see chart a. Oil  prices and oil price shifts have the ability to have a big impact on economic  growth and inflation, through the effect on incomes and from the monetary policy  response. But higher oil prices elicit a strong response in another way as well  - by inducing energy efficiency and technical change that reduce the amount of  oil used in output and so ultimately reduce the real price of oil. That is what  is implied in chart a, which shows that after peaking in the 1970s, real oil  prices then fell steadily in the 1980s and remained at very low levels for the  next 20 years, only starting to rise in a consistent manner since 2004.  

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[B][B][B][B][B] Other Pre-screened Independent Contributors[/B][/B][/B][/B][/B]

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[I] J-Chart [/I]

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Compiled by David Song, Currency Analyst[/B]