The rising value of the U.S. dollar against most other major currencies is creating an additional headwind for oil prices, as it pushes up the local price of crude and fuels across much of Asia, Europe and Latin America. In trade-weighted terms, the dollar has risen to its highest since late 2016 and early 2017, and before that 2002/2003.
Adjusted for inflation, the dollar’s trade-weighted value is close to its highest since 2004, according to the broad exchange rate index compiled by the Federal Reserve. The U.S. dollar has appreciated by more than 8 percent against China’s yuan since the end of March, in response to the worsening trade tensions between the two countries.
China overtook the United States to become the world’s largest crude importer in 2017 and net imports of crude and fuels are now running at around 9 million barrels per day. Brent crude prices have risen nearly 9 percent this year in dollar terms but are up more than 13.5 percent in yuan as a result of the exchange-rate shift.
China’s currency depreciation is partly driven by bilateral tensions as the country’s authorities actively engineer or passively permit the exchange rate to act as a shock absorber (the practical effect is the same). But the U.S. dollar has also appreciated against every other major currency, including the euro, the Japanese yen, the British pound, the South Korean won and the Canadian dollar.
The U.S. currency is also rising against most emerging-market currencies, including the Brazilian real, the Indian rupee and the Indonesian rupiah. In general, it is the U.S. dollar appreciating rather than other currencies depreciating, mostly as a result of strong economic growth in the United States, steadily rising interest rates and safe-haven capital flows.
The result is that oil prices in most oil-consuming countries are now rising much faster than the international benchmark prices quoted in dollars. There is no simple and stable relationship between exchange rates and oil prices quoted in dollars – the two have sometimes been correlated and sometimes not.
Exchange rates are only one of many influences on the price of oil, and the relationship is not strong or predictable enough to be tradeable.
But a strong dollar is generally associated with lower benchmark oil prices, and vice versa, all other things being equal. The last period of very high oil prices between 2011 and the first half of 2014 coincided with a period of dollar weakness, which cushioned the impact in many major oil-consuming countries.
But oil’s recent rise has been accompanied by a strengthening dollar, especially in recent months, which will intensify the impact on consumers. Many emerging markets also took advantage of low oil prices in 2015 and 2016 to scale back fuel subsidies and price controls.
Consumers in many of the fastest-growing fuel markets are being exposed to the impact of pricier oil much more than before.
Gasoline and diesel prices in India, for example, one of the fastest-growing fuel markets, recently hit record levels because of a cocktail of higher crude prices, a stronger dollar, fiscal changes and the reduction of price controls. If the U.S. dollar continues to strengthen, rising oil prices are likely to prompt a much larger demand-response from consumers than in 2011-2014. In the current oil-price cycle, demand restraint is likely to be felt much faster and more aggressively than in 2006-2008 or 2011-2014, so long as the dollar remains strong.