The conflict in the Middle East, now in its 11th week, has led to the closure of a vital shipping channel and a sharp spike in energy prices.
Against this backdrop, the direct correlation between the US dollar and oil prices has reached an all-time high, according to Bloomberg.
The correlation between the Bloomberg Dollar Spot Index and Brent crude oil futures is currently at its highest level since the currency indicator was launched in 2005. In other words, the synchronicity between daily fluctuations in oil prices and the US dollar has reached its highest level in more than two decades.
The direct (positive) correlation between these assets is historically atypical. Most oil trades are conducted in US dollars (the so-called petrodollar system). This typically means that traders expect a decline in oil demand with a sharp strengthening of the US dollar. However, the conflict in Iran triggered a simultaneous rise in both the dollar and oil prices.
The price of a barrel of Brent crude has soared by approximately 45% since late February, when the US and Israel launched their first strikes on Iran, forcing Tehran to effectively shut down shipping through the Strait of Hormuz. This week, the IEA stated that the market will experience an "acute supply shortage" until October.
For most of the first quarter, the dollar and oil were inversely correlated, but in early March, it became positive and has remained so ever since.
"There are periods when macroeconomics is the primary driver of market movements. But there are also periods, like now, when geopolitics, news headlines, risk appetite, and market momentum take center stage," notes Brent Donnelly, president of Spectra Markets. "Right now, the entire narrative boils down to one thing: oil is up or oil is down." This makes it increasingly difficult for traders to rely on other fundamental drivers of exchange rates (such as interest rate differentials or economic growth data), which investors have traditionally considered key when assessing currency valuations.
"Barring a sharp collapse in equity markets, moderate currency movements will continue to be driven by further oil price hikes and the response of central banks (including the Fed) to rising inflation," Chris Turner, head of foreign exchange strategy at ING Bank NV, wrote this week.