The day after crude oil prices rose almost 5% the dogma of the dollar versus oil inverse relationship has come to a screeching halt ahead of the most exciting FOMC meetings in a decade. As the Fed moves closer to raising interest rates and getting closer to a normalization of interest rate policy the correlation between the dollar and oil is breaking down.
Bloomberg News Reported that, "The link between crude oil and the dollar has broken for the first time in more than a year, limiting the effect of any Federal Reserve rate change as the industry struggles with a supply glut. The 120-day correlation between West Texas Intermediate futures and the U.S. Dollar Index moved near zero last week, according to data compiled by Bloomberg. The measure has mostly been negative during the past 10 years as the greenback and crude tend to move in opposite directions. It was at 0.011 Wednesday."
But I think the break down has little to do with the oil supply glut but more to do with the Fed. I predicted this in articles that I wrote for the "International Banker Magazine" and in "Trader Planet" because the Fed and its Quantitaive Easing (QE) is the main reason for oil versus dollar inverse relationship. The dollar-oil correlation hit its zenith at the start of the financial crisis in 2008/2009 when the correlation ran near 60%. The reason for the high correlation was the strength or weakness of currencies was reflecting a shifting of risk assets to try to find a safe haven against what was an unfolding economic crisis.
Because even though in the short run, the dollar is weighing on oil prices, the fact that the Fed is normalizing rates should mean that the U.S. economy is finally starting to heal and will bode well for energy demand. Even in the economies that are struggling, we should see demand grow as more QE and lower interest rates will increase demand. If demand starts to spark, the price of oil will break away from its dollar value related change as the glut of oil starts to dry up.
The glut will dry up not only because demand will improve, but because the recent price fall caused a massive pullback in energy investment, which eventually took a toll on U.S. production. With rig counts in the U.S. falling at a record pace, the U.S. output will fall later this year just as global demand starts to improve. This will start an oil demand price run that should bring prices back toward the $80 a barrel area. History shows that that inverse relationship overtime does not always exist. In fact many times it does not and it seems that now is one of those times.
As I wrote yesterday the drawdown in the Nymex delivery point in Cushing, Okla., is showings signs of U.S. oil output rolling over. The Energy Information Administration reported another draw in Cushing of 1.906 million barrels. The ultra bears said this was not supposed to happen. Demand for oil is also strong as refinery runs surprisingly popped to a near record 93.1%. We also saw a big drop in Midwest crude supply signaling a drop in Canadian production as well.
The end of an era? Not just for the United States but the global energy market. The Wall Street Journal reports that "Saudi Arabia's state-owned giant oil company, Saudi Aramco, said Thursday it has named a new president and chief executive following a shake-up of the country's ministerial elite earlier this year.
Amin H. Nasser was named by the Saudi Aramco Supreme Council as the president and chief executive of Saudi Arabian Oil Co., known as Saudi Aramco. In May, Mr. Nasser, who was previously Aramco's senior vice president for upstream operations, was promoted to acting president and CEO of the company.
The changes within Aramco have fed speculation that long-standing oil minister Ali al-Naimi may be preparing to retire. The influential oil official, who has been Saudi Arabia's top oil executive since 1995, has already said he wants to step down. Mr. Falih is often considered a possible candidate to replace him, alongside the king's son and deputy oil minister, Prince Abdulaziz bin Salman.