Dollar Recovers on Back of Oil Price Surge

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Surprise production cut from OPEC propels oil prices higher, benefiting the Dollar.

Oil prices shot higher to enter the new week, supercharged by a surprise announcement that OPEC+ will slash its production.

The cartel and its allies said crude supply will be trimmed by 1.16 million barrels per day from May onwards, helping restore some balance in a market that has been plagued by demand concerns.

When OPEC axes production, it is ultimately trying to shore up oil prices by closing the supply taps, but the move also indicates the cartel expects demand conditions to weaken further.

It’s clearly not a vote of confidence in the global economic outlook, although it does help establish a soft floor under oil prices for now.

Beyond oil prices, the spike in energy costs has revived concerns over the persistence of inflationary pressures, fueling speculation that the Fed might have one last card to play in its tightening cycle.

Market pricing currently points to a 65% probability for a final rate increase next month, while bets for rate cuts later this year have started to recede.

The surge in energy prices stole the thunder from some encouraging U.S. inflation readings on Friday.

The softer core PCE metric fueled hopes that inflation is finally losing its kick, but the move from OPEC dealt a heavy blow to these expectations, signalling that the inflation battle has not been won yet.

Rising bets for one final rate increase breathed some life back into the US dollar, which had suffered collateral damage lately as investors wagered that the banking episode would tie the Fed’s hands.

The ISM manufacturing survey today will help shape this narrative, although the main event this week will be Friday’s nonfarm payrolls report.

Gold was on the ropes as the new trading week got underway, feeling the heat of a recovery in the US dollar and Treasury yields.

Yet, the losses were trimmed as buyers stepped in to defend the $1950/ounce region, which suggests dip-buying is still the game plan among investors as the recent Fed liquidity injections work their magic.

Central banks raising their reserves might be another reason for the resilience in gold.

The People’s Bank of China has been buying like a whale since last year to diversify the nation’s reserves and insulate it from the risk of foreign sanctions.

It will be paramount to see whether this pattern continues when the latest data on Chinese reserves is released Friday.

The stock market has been living in another dimension this year, with the Nasdaq 100 rising by more than 20% to close the first quarter.

Speculation is riding high that the market low in October last year was the bottom of this cycle, and that the recent strength in the economic data pulse points to an economy headed for a soft landing.

In reality, this incredible rally has been fueled primarily by a radical change in the liquidity profile.

With the Fed opening the liquidity floodgates and expanding its balance sheet again to protect the banks, there’s been a ‘buy everything’ impulse in riskier assets from tech shares to Bitcoin.

Once this sugar high fades though, investors will need to grapple with how stretched valuations have become heading into a potential earnings recession.

Next on the agenda is the Reserve Bank of Australia’s rate decision early on Tuesday. The central bank is expected to hit the 'stop' button in its tightening cycle, mindful of a streak of disappointing economic data lately and the risks surrounding its housing market.

Marios Hadjikyriacos is Senior Investment Analyst at XM.com. An original version of this article can be found here.