Dollar’s Slide Defies Oil and Rate Trends
The U.S. dollar weakens despite falling oil prices, as trade policy uncertainty and euro ambitions reshape currency markets
Ira Kalish
The value of the U.S. dollar continues to decline, with the value of the euro against the dollar recently rising to the highest level since 2021.
Many factors can drive currency values.
Often when the price of oil rises, the value of the dollar declines.
Rising oil prices reduce demand for oil, and since oil is traded in dollars, weaker demand for oil means weaker demand for dollars.
Lately, however, the price of both oil and the dollar fell, indicating that other factors evidently influenced the dollar’s value.
Disparity between monetary policies, or at least disparity between expectations regarding monetary policy, also drives currency values.
The European Central Bank (ECB) is on a path of monetary easing, with an expectation that this will continue.
Meanwhile, the U.S. Federal Reserve is taking a wait-and-see approach, with investors now expecting less monetary easing by the Fed than by the ECB.
This set of circumstances suggests a rising U.S. dollar.
Yet that has not been the case.
However, the futures markets indicate that investors’ implied probability of ECB rate cuts has declined slightly due to the rise in oil prices since last week, which might partially explain the rise in the euro.
In any event, the continuing decline in the value of the U.S. dollar is most likely associated with the continuing trade policy of the U.S. and the uncertainty surrounding this policy.
The expectation that the U.S. role in global trade will diminish potentially means less demand for dollars.
Plus, uncertainty and a perception of unpredictable policy also leads investors to diversify portfolios to reduce exposure to U.S.-related risk.
These factors appear to be outweighing the impact of oil prices and monetary policies.
Reportedly, French President Emmanuel Macron is urging other leaders within the European Union (EU) to take steps to make the euro a more important global currency, specifically through the issuance of joint EU debt.
Indeed, International Monetary Fund Managing Director Kristalina Georgieva said that “There is a great opportunity for the euro to play a bigger role globally.
When I look at the search for quality safe assets, at this point it is facing a constraint on the offering of these assets.
It is not by chance that so much now is being parked in gold.”
Oil Prices and War
With Israel and Iran at war, the price of oil is elevated, having risen sharply when the conflict intensified on June 13.
However, the price has settled at only a slightly elevated level as investors began to believe that the war is not likely to disrupt oil supplies.
For the war to disrupt oil supplies, Iran would have to use force to close the Straits of Hormuz, a capability that they might lack following massive Israeli attacks on Iran’s military.
Moreover, even if there is disruption in the Straits, Saudi Arabia has pipelines that can deliver Persian Gulf oil to the Red Sea for shipping.
And, even before the war began, the Saudis had chosen to boost oil production, offsetting the impact of Israeli attacks on Iran’s oil producing facilities.
Thus, the world’s oil supply appears to be relatively safe.
Indeed, historically, conflict in the Middle East has rarely had a significant impact on the global economy.
The only times in modern history that such events were truly disruptive were in 1974 and 1979.
In 1974, the war between Israel and Egypt led Arab oil producers to impose a boycott of Western countries for supporting Israel.
This led to a quadrupling of the price of oil.
In 1979, the Iranian revolution disrupted Iran’s oil production at a time when oil supplies were tight, thereby causing a doubling of the oil price.
In both cases, global inflation soared while real income declined.
Tighter monetary policies brought on recession in most major economies.
Yet, when oil prices surged in 1990 following the Iraq-Kuwait conflict, the impact was short lived.
The same was true in 2003 during the U.S.-Iraq conflict and in 2022 during the start of the Russia-Ukraine conflict.
This time is likely to be similar.
—by Ira Kalish, chief global economist, Deloitte Touche Tohmatsu Limited
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