Why Higher Oil Prices Are a Dollar Catalyst
The way I see it, higher crude oil prices are acceptable, but higher prices over a prolonged period of time are not. Iran is not only fighting the U.S. in response to the initial attacks, but it’s also firing missiles at neighboring countries, trying to hit refinery infrastructure. Perhaps they are trying to anger OPEC into putting pressure on the U.S. to stop the fighting — I don’t know for sure. But I do know that damaged infrastructure can’t produce oil, so the move qualifies as a possible supply disruption.
I think the market was ready for the closing of the Strait of Hormuz, a key waterway that tankers use to transport oil to Europe and Asia. It accounts for about 20% of global production. The Strait can open and close at will, depending on how strong Iran’s defense of the area is. According to Iranian media, it’s closed. However, infrastructure damage can take months to repair, meaning that the world may face a more prolonged shortage of oil than previously anticipated.
Inflation Fears Put the Fed Back in Focus
This is where the rise in the dollar comes into play. Elevated oil prices are inflationary and it’s something the world may not be ready for, especially with the European Central Bank (ECB) already focused on maintaining a low rate environment. Meanwhile, the Fed has been sitting on the fence about cutting rates. The market anticipates at least two rate cuts this year, but the Fed has been committed to the data. Friday’s jobs report will encourage the Fed to lean either way, but a big jump in inflation will force the Fed to remain on hold, and may even push them toward a rate hike.
It’s inflation and rate hike fears that are driving the U.S. Dollar higher. The higher crude oil moves for longer, the greater the odds of a Fed rate hike, and that is scary for dollar short-sellers, who previously bet big on the Fed cutting rates.
If conditions improve in the Middle East then the dollar could retreat quickly, but if they worsen over time, the U.S. Dollar could jump another 10% from current levels.
