US Dollar: Its All a Question of Oil and the Fed, says SocGen’s Juckes

The outlook for the Dollar Index remains dependent on the price of oil and the Fed’s tightening trajectory, according to Societe Generale’s Kit Juckes.

“..a broad dollar turnaround is unlikely until both the Fed's tightening cycle has been priced in, and the price of oil has turned up.” He wrote in a research note on Tuesday.

The correlation between oil and a “Broad TWI” of the dollar was “impressive,” according to the analyst, despite some anomalies such as the dollar-rouble pair, in which the Russian currency was even more correlated than the greenback with oil.

Indeed this relationship was evidenced in currency markets on Wednesday, which saw the dollar strengthen against most commodity currencies following the release of inventory data which showed a rise in inventory surpluses when a negative reading had been forecast, in line with seasonal expectations. 

Juckes also noted how the U.S currency had started to correlate closely with U.S Treasury yields – an indicator of Fed rate hike expectations – and how this was another factor in dollar valuations:

“Correlation isn't the same as causation, but we are back in a similar world to the one we saw before this year, when a 1% move in 2-year rates was associated with a 12-figure move in EUR/USD.”

According to this “super-simple measure” EUR/USD should reach parity if 2-year US rates moved to 2% (from a current level of 1.083).

Saudi Budget could keep the price of oil down

Although the price of oil has been broadely strong in recent weeks, analysts have put this down to temporary factors such as forecasts for lower temperatures in the U.S and Hedge Funds closing their short positions ahead of year-end reporting.

The longer-term outlook for oil prices is not as positive, with the recent Saudi budget, released on Monday, showing the government is more likely to seek spending cuts than to cut its supply of oil to reduce the 98bn dollar budget deficit. 

Another factor which is expected to weigh on prices is the probable reintroduction of Iranian oil on the international market after sanctions are lifted, which according to the Financial Times is likely to be quite soon:

“The market is expected to remain oversupplied in 2016 as Riyadh resists calls for production restraint and Iran, once Opec’s second-largest producer, prepares to increase output once sanctions linked to its nuclear programme are lifted.

It seems an Iran nuclear deal is currently on track after reports Tehran dispatched a shipment of more than 11 tones of low enriched Uranium to Russia imporved odds of sanctions being lifted.

According to some analysts Iran is planning to flood the market with 500,000 barrels of oil a day whilst the ceasefire in Libya may add even more.

Yields Hold Higher after Bond Sales

U.S Treasury yields have been rising strongly ever since the autumn, but in particular since the Fed made its first rate rise in December.

Expectations that yields would continue rising based on the likelihood that the Fed would make more rate hikes, found support this week after a U.S Treasury auction of 5-year notes saw gains before and after, with the Treasury selling 35bn at a high yield of 1.785%.

On Monday, an auction of 2-year notes, showed a fall in demand with a consequent rise in yields to 1.0560 – and since then yields have risen even higher to 1.0830.