The consequences of the
dollar’s effect on energy
prices has heightened concern
as oversized movements
in oil and derivative
products directly affect businesses and
consumers—and make monetary policy
that much more difficult to manage for
global central banks.
Over the past few years, the decline in
the general value of the dollar has been
negatively correlated to the price of a
barrel of oil (see chart). As the dollar
went down, the price of oil shot up—often
more violently—as so-called “speculative”
buying pushed prices to extremes.
The correlation is based on the notion
that oil producers don’t have an incentive
to increase production or lower the price
of oil when the dollar made on its sale is
declining. To make up for the loss in the
value of the dollar, the price of oil is simply
allowed to move higher by the producers.
Of course, the movement of oil is not
dependent on the movement of the U.S.
dollar, nor is the price of the dollar dependent
on the price of oil. Many other
factors have contributed to the price spike
in oil, including an increase in global demand
from emerging countries.
It’s hard to differentiate “real” demand
from short-term speculative demand, especially
if speculators begin to trade correlated
instruments—like the U.S. dollar
as a proxy for oil. Nevertheless, the link
between oil and the dollar has been noticed
by the market and traded actively as
a result. So what are the implications of
the dollar and oil correlation to central
bankers trying to guide monetary policy?
For a country like the United States, a
stronger dollar would in theory lower oil
prices, or at least keep them steady. It
may also have the effect of lessening the
speculative buying that some suggest is
contributing to oversized gains. Finally, it
might solicit new supply from producers
who may be withholding with the hope
of getting a higher price.
For other countries, however, the effects
of the oil-price spike have varying
degrees of inflationary implications, depending
on the nation’s currency value
versus the U.S. dollar. The change in the
price of a gallon of gas in the U.S., Germany,
and United Kingdom from April
2007 to April 2008 provides an illustration.
Because the U.S. is so dependent on
oil, its price can have a major implication
on the strength or weakness of the economy
and the underlying inflation. The
U.S. is also unique because the price of a
barrel of oil is denominated in U.S. dollars,
so as the price goes up and down,
there are no currency effects that can benefit
or hurt inflation.
From April 30, 2007 to April 30, 2008,
the price of gas in the U.S. rose from
$2.97 to $3.60 per gallon, an increase of
21%. Over that same period, the U.S.
Consumer Price Index rose by 3.9% and
2.7%. Energy alone (including gas and
heating oil) added 1.2% to the inflation
rate over the April 2007 to April 2008
period. Thirty percent of the U.S. inflation
was caused by higher energy.
In April 2007, one euro could be exchanged
for $1.3647 U.S. dollars, and on
April 30, 2008, the same euro could be exchanged
for $1.5622 U.S. dollars. Because
oil is denominated in U.S. dollars, the currency
effect for importing oil into the Eurozone
is the equivalent of a discount of
14.5% for Eurozone countries.
Therefore, if the cost of a dollar declines
from one year to the next, the
change in the price of a gallon of gasoline
in the Eurozone would be less than the
U.S., and the inflation caused by higher
energy will also be less. It’s one of the
benefits of maintaining a stronger currency.
Using Germany as a proxy for European
Union members, the price of a gallon
of gas has gone from 5.11 euros on
April 30, 2007 (1.35 euros per liter) to
5.33 euros on April 30, 2008 (1.41 euros
per liter). This is equal to a price increase
of only 4.4% for the year—much lower
than the 21% jump in the U.S. The Eurozone
benefited from having lower imported
energy costs as a result of the
stronger euro.
In contrast, over the same period, the
The Dollar, Oil, and Inflation:
It’s Time for Some Support
BY GREG MICHALOWSKI
Following Forex
value of the GBP/USD did not increase
like the euro. The U.K., like the U.S., eased
rates to fix their economic woes, which
put pressure on their currency. In fact,
from April 30, 2007 to April 30, 2008, the
GBP/USD declined slightly from 1.9996
to 1.9866. Instead of the dollar getting
weaker, it strengthened slightly against
the pound sterling. Because the currency
pair was nearly unchanged, the expectation
would be that the price of petrol in
the U.K. would have risen at a similar
pace to that of the U.S.
Lo and behold, from the end of April
2007 to the end of April 2008, the price
of a gallon of petrol went from 3.47
pounds to 4.17 pounds. The percentage
gain of petrol prices in the U.K. was
nearly identical to the 21% gain experienced
in the U.S.
Despite the gains in the euro over the
last year, the inflation rate in the Eurozone
as measured by the CPI hasn’t been
able to benefit from the “exchange-rate
kicker” that lowered the price of imported
oil. Eurozone inflation as measured
by the CPI rose from 1.9% in April
2007 to 3.3%. The rate is likely to go
higher.
In the U.K., the CPI inflation rate recently
moved back to the upper band of the
target range, and it too is expected to continue
to trend higher. This is despite slower
growth that has hit the U.K. economy.
Moreover, for the first time in a long
while, the link between the falling dollar
and the price of oil decoupled over the
last month. Since April 30, the price of oil
has shot up from $113.46 per gallon to
$128.40 on May 27, while the value of the
dollar against the EUR/USD and the
GBP/USD has risen slightly.
As a result, the worst-case scenario for
all central banks has occurred. Countries
are forced to shoulder the burden of the
higher prices, and indeed the price of
petrol in all three countries has increased
by greater than 6% over the last month
alone.
Though the remedy might be hard to
swallow, it might be a better bet than waiting
for “the U.S. dollar [to regain] its
strength over time,” as Treasury Secretary
Henry M. Paulson Jr. has predicted.
With housing inventory at a record 11-
month supply, inflation on the rise from
higher import costs, and high oil and
commodity prices—and with global demand
likely to slow, too—the moment
of truth is fast approaching.
The Federal Open Market Committee
must take steps to support the dollar—
and not just through a temporary fix with
the hope of jump-starting the economy.
Cutting rates isn’t working. Stopping
inflation, even at the expense of slowing
growth, may be the best medicine at the
moment. By doing so, the price of oil can
settle back down, confidence in the U.S.
can return, and the woes that are building
can heal.
Greg Michalowski is vice president of trading
and chief FX analyst for FXDD, an online foreign
exchange liquidity provider for retail traders
and investment managers. For daily market commentary
on the foreign exchange market, visit
forex.fxdd.com.
dollar’s effect on energy
prices has heightened concern
as oversized movements
in oil and derivative
products directly affect businesses and
consumers—and make monetary policy
that much more difficult to manage for
global central banks.
Over the past few years, the decline in
the general value of the dollar has been
negatively correlated to the price of a
barrel of oil (see chart). As the dollar
went down, the price of oil shot up—often
more violently—as so-called “speculative”
buying pushed prices to extremes.
The correlation is based on the notion
that oil producers don’t have an incentive
to increase production or lower the price
of oil when the dollar made on its sale is
declining. To make up for the loss in the
value of the dollar, the price of oil is simply
allowed to move higher by the producers.
Of course, the movement of oil is not
dependent on the movement of the U.S.
dollar, nor is the price of the dollar dependent
on the price of oil. Many other
factors have contributed to the price spike
in oil, including an increase in global demand
from emerging countries.
It’s hard to differentiate “real” demand
from short-term speculative demand, especially
if speculators begin to trade correlated
instruments—like the U.S. dollar
as a proxy for oil. Nevertheless, the link
between oil and the dollar has been noticed
by the market and traded actively as
a result. So what are the implications of
the dollar and oil correlation to central
bankers trying to guide monetary policy?
For a country like the United States, a
stronger dollar would in theory lower oil
prices, or at least keep them steady. It
may also have the effect of lessening the
speculative buying that some suggest is
contributing to oversized gains. Finally, it
might solicit new supply from producers
who may be withholding with the hope
of getting a higher price.
For other countries, however, the effects
of the oil-price spike have varying
degrees of inflationary implications, depending
on the nation’s currency value
versus the U.S. dollar. The change in the
price of a gallon of gas in the U.S., Germany,
and United Kingdom from April
2007 to April 2008 provides an illustration.
Because the U.S. is so dependent on
oil, its price can have a major implication
on the strength or weakness of the economy
and the underlying inflation. The
U.S. is also unique because the price of a
barrel of oil is denominated in U.S. dollars,
so as the price goes up and down,
there are no currency effects that can benefit
or hurt inflation.
From April 30, 2007 to April 30, 2008,
the price of gas in the U.S. rose from
$2.97 to $3.60 per gallon, an increase of
21%. Over that same period, the U.S.
Consumer Price Index rose by 3.9% and
2.7%. Energy alone (including gas and
heating oil) added 1.2% to the inflation
rate over the April 2007 to April 2008
period. Thirty percent of the U.S. inflation
was caused by higher energy.
In April 2007, one euro could be exchanged
for $1.3647 U.S. dollars, and on
April 30, 2008, the same euro could be exchanged
for $1.5622 U.S. dollars. Because
oil is denominated in U.S. dollars, the currency
effect for importing oil into the Eurozone
is the equivalent of a discount of
14.5% for Eurozone countries.
Therefore, if the cost of a dollar declines
from one year to the next, the
change in the price of a gallon of gasoline
in the Eurozone would be less than the
U.S., and the inflation caused by higher
energy will also be less. It’s one of the
benefits of maintaining a stronger currency.
Using Germany as a proxy for European
Union members, the price of a gallon
of gas has gone from 5.11 euros on
April 30, 2007 (1.35 euros per liter) to
5.33 euros on April 30, 2008 (1.41 euros
per liter). This is equal to a price increase
of only 4.4% for the year—much lower
than the 21% jump in the U.S. The Eurozone
benefited from having lower imported
energy costs as a result of the
stronger euro.
In contrast, over the same period, the
The Dollar, Oil, and Inflation:
It’s Time for Some Support
BY GREG MICHALOWSKI
Following Forex
value of the GBP/USD did not increase
like the euro. The U.K., like the U.S., eased
rates to fix their economic woes, which
put pressure on their currency. In fact,
from April 30, 2007 to April 30, 2008, the
GBP/USD declined slightly from 1.9996
to 1.9866. Instead of the dollar getting
weaker, it strengthened slightly against
the pound sterling. Because the currency
pair was nearly unchanged, the expectation
would be that the price of petrol in
the U.K. would have risen at a similar
pace to that of the U.S.
Lo and behold, from the end of April
2007 to the end of April 2008, the price
of a gallon of petrol went from 3.47
pounds to 4.17 pounds. The percentage
gain of petrol prices in the U.K. was
nearly identical to the 21% gain experienced
in the U.S.
Despite the gains in the euro over the
last year, the inflation rate in the Eurozone
as measured by the CPI hasn’t been
able to benefit from the “exchange-rate
kicker” that lowered the price of imported
oil. Eurozone inflation as measured
by the CPI rose from 1.9% in April
2007 to 3.3%. The rate is likely to go
higher.
In the U.K., the CPI inflation rate recently
moved back to the upper band of the
target range, and it too is expected to continue
to trend higher. This is despite slower
growth that has hit the U.K. economy.
Moreover, for the first time in a long
while, the link between the falling dollar
and the price of oil decoupled over the
last month. Since April 30, the price of oil
has shot up from $113.46 per gallon to
$128.40 on May 27, while the value of the
dollar against the EUR/USD and the
GBP/USD has risen slightly.
As a result, the worst-case scenario for
all central banks has occurred. Countries
are forced to shoulder the burden of the
higher prices, and indeed the price of
petrol in all three countries has increased
by greater than 6% over the last month
alone.
Though the remedy might be hard to
swallow, it might be a better bet than waiting
for “the U.S. dollar [to regain] its
strength over time,” as Treasury Secretary
Henry M. Paulson Jr. has predicted.
With housing inventory at a record 11-
month supply, inflation on the rise from
higher import costs, and high oil and
commodity prices—and with global demand
likely to slow, too—the moment
of truth is fast approaching.
The Federal Open Market Committee
must take steps to support the dollar—
and not just through a temporary fix with
the hope of jump-starting the economy.
Cutting rates isn’t working. Stopping
inflation, even at the expense of slowing
growth, may be the best medicine at the
moment. By doing so, the price of oil can
settle back down, confidence in the U.S.
can return, and the woes that are building
can heal.
Greg Michalowski is vice president of trading
and chief FX analyst for FXDD, an online foreign
exchange liquidity provider for retail traders
and investment managers. For daily market commentary
on the foreign exchange market, visit
forex.fxdd.com.
