A weaker US dollar should continue to provide a healthy counterbalance to any US inventory overhang as investors will be on the search for alternative investments to hedge the anticipated wave of US dollar weakness in the weeks and months to come.
Indeed, the weaker US dollar boosts the demand for commodities in general and is bullish for oil prices.
For the time being, oil has become more of a relative value trade but in the context of the incredulous amounts of global stimulus on offer and the Federal Reserve Board, who is expected to hose down the dollar this week.
In this situation, oil and other commodities can be viewed as an alternative asset to hedge dollar depreciation.
As discussed last week, above and beyond traditional fundamental factors (OPEC compliance and global demand), an additional speculative appeal has probably been supporting oil prices driven by the weaker US dollar.
By using a simple regression equation, a weakening of the effective exchange rate of the US dollar of 1% has, on average, been accompanied by a rise in the Brent oil price of 2.0%.
The current DXY is already factored in the current prompt price, so prices in the lead up to the FOMC could then move tangentially to the US dollar index.
However, it would make sense for investors to go long oil as an alternative investment to hedge against the plethora of large FX global trading banks forecasted 5% drop in USD broad-trade weighted average.
For prompt oil, at a minimum, the weaker US dollar provides a durable backstop for Oil bulls to remain in the game while waiting for the US and global Covid-19 case count curve to bend lower.
September Crude didn’t quite make $45 last week and then sold off as US markets traded down after the US claims data and uncertainly over the US Covid-19 relief bill, all the while US-China tensions continue to bubble.
The US Coronavirus Aid, Relief, and Economic Security (CARES) provided extra money to households through one-time checks and supplemental unemployment insurance (UI) benefits, increasing total personal income through May despite a nearly 9% drop in wages.
However, the extra USD600/week in UI money ends this week. Investors expect the US Congress to extend some of the provisions, but uncertainty runs high as to the details.
But for growth assets like oil, “bigger is the better,” so there could be some level of disappointment if Congress rushes out a bill that doesn’t meet current standards.
As for the US-China frictions, the market’s primary thesis on what ultimately matters for growth assets is whether a US-China geopolitical escalation morphs into an economic dust-up. The market thinks that quashing the P1 trade deal before the election as the last thing the US economy needs amid the Covid-19 recession.
Ultimately rolling back the P1 trade deal would dent stock market sentiment, a causality that President Trump would vehemently oppose in a run to the 2020 elections.
Oil markets analysis and insights from Stephen Innes, Chief Global Market Strategist at AxiCorp