The oil price could tread water or go lower over the coming months, even as global oil demand slowly increases – because of a surprisingly steady and rising US dollar.
Surprisingly, because US economic data is not all that strong, so in one sense the dollar has no reason to go up. Same store sales at Walmart and McDonalds are down. Government tax receipts are lower.
But if Europe is falling apart with Greece’s debt problems (and investors worried about a domino effect into Spain & Portugal), so the Euro has to go down against something – the US dollar. And China is reducing money supply (forcing the borrowers of yuan to repay it back, driving the Yuan higher) so to prevent the Yuan going higher against the greenback, the Chinese buy US dollars.
And once the US dollar starts to appreciate, it could (is?) create a tidal wave of unwinding carry trade positions. At its most basic (and I try to keep it all very simple) speculators borrow in US$, invest in currencies with higher interest rates & capture the spread – and hope the US$ goes lower against that currency as well.
It’s highly unlikely that it will be on the scale of late 2008, where this unwinding caught everyone off guard and positions had to be squared quickly and painfully. The fact that people are talking about it now means, to me, that it will not be as severe as late 2008. But the current unwinding of the carry trade against the US dollar does have the potential to be large enough to keep the greenback elevated for several months or more.
For the last few years, oil has had an inverse relationship with the US dollar. So even though global oil demand may increase slightly in 2010, currency flows – i.e. a higher US dollar – could overwhelm fundamentals (isn’t that a novelty) in the oil market and take the oil price lower.
Just a thought.
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