Crude Oil Prices Climb While Dollar Weakens

The price of crude oil has risen to nearly $85 a barrel in the last few weeks, creating a rumble in the trading pits of Wall Street.  Traders and market strategists are debating what kind of impact high oil prices will have on frustrated consumers already stressed by the struggling economy. Industry insiders refer to this impact as “demand destruction.”

Commodities, which are mainly dollar-denominated, are aided by a weakening U.S. currency.  Since 2008, the Federal Reserve’s quantitative easing measures coupled with near-zero interest rates have spurred investors to buy commodities and stocks with borrowed money.  Cheap and cheapening dollars continue to stimulate this carry trade.

The Federal Reserve’s commitment to avoid deflation and help the sluggish U.S. economy is one major cause of crude oil’s 11% September rally.  By continuing to pour dollars into the system, deflation is kept in check, but oil prices keep creeping up.

The movement of oil prices to over $80 per barrel in early October followed a 9% drop on the dollar index in September.  The dollar index, a comparative measure of the U.S. dollar and other major currencies, reacted to the very real probability that the Federal Reserve would provide additional stimulus.  The index has plunged a total of 16% since June.

Tariq Zahir, managing member of Tyche Capital Advisors, pointed out that fundamentals are not the driving force behind oil’s price jump.  “There’s definitely concerns about the recovery and demand destruction while crude is being [lifted] by the dollar.  Fundamentally, there’s enough [crude] out there and we should head lower,” Zahir said.

Other analysts note that increasingly stressful conditions in the rest of the economy present a greater worry than the exact dollar level.  Safeway reported prices for consumers climbed while its difficulties with deflation eased.  Rising food prices are coinciding with rising crude oil prices. Dave Rosenberg, Gluskin Sheff chief economist, sees higher gas prices following the $84 per barrel crude cost.  He notes that a major difference between the last commodity boom in 2007 and what is happening now is a current unemployment rate of 9.6% instead of the less than 5% rate recorded 3 years ago.

As long as the effectiveness of the quantitative measures is an uncertainty, falling dollar values and increased prices will remain a problem.  There should be some relief after the Federal Reserve announces new quantitative measures in November.  Many analysts predict a correction in stocks and commodities.  Because the market has already priced in new measures, the dollar should rebound – at least temporarily.