After coming unwound between February and May of this year, a strong inverse correlation between oil and the U.S. dollar is again present. The chart above depicts the inverse relationship between the price of crude and the strength of the U.S. dollar. The average purchasing power of the U.S. dollar compared to the Euro has been 0.71 over the past three years. Today, one dollar buys 0.78 Euros, indicating that the dollar is now 10% stronger versus its three-year average.
Typically, if the dollar drops in value then oil prices move in the opposite direction (i.e. higher), the converse is also true. Evidenced this summer when crude prices peaked in early August at nearly $82/bbl, the dollar was trading at its monthly low of 0.75 Euros. Subsequently, the dollar's strength has intensified and the price of oil has fallen in lock-step.
The current correlation between crude and the dollar is negative 0.82, double the one year average correlation of -0.41. Re-coupling of the inverse correlation relationship took place in March 2010 following a 13-week period when oil prices were more likely to move in the same direction as the dollar. The highest the inverse correlation has been over the last five years is -0.98, which occurred during the height of oil's price correction after its peak in 2008.
Today, crude futures were off more than $1 per barrel at $73 and change this morning while the dollar was stronger against the Euro. An article from the Wall Street Journal highlighting how stress tests on European banks showed some banks had underestimated exposure to sovereign debt is seen as today's catalyst for the Euro's weakness. In addition to swings in the U.S. dollar, the direction of the broader markets also plays a hand in determining crude prices. We will delve into this relationship and discuss recent findings comparing the correlation between crude and the S&P 500, tomorrow.
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