HedgeTalk: Strengthening Dollar, Weakening Oil
By: Johan Rosenberg, Chairman
At the end of last week, I surveyed US economic indicators and trends in equities, commodities, bond yields and currencies. Two indices stood out in sharp contrast to the others - the DXY Dollar Index (“DXY”), which is an index of the value of the US dollar (the “Dollar”) relative to a basket of foreign currencies, and the energy index (“Energy”). As shown in the table below, both are down significantly on an annualized basis.
Driving Energy down has been depressed demand world-wide due to COVID-19. DXY is down primarily due to speculators who, according to the Commodity Futures Trading Commission, have been shorting the dollar for almost ten weeks.
Assume for a moment that the Dollar is over-sold (at least in the short run), and pessimism is exaggerated. What if we experience a short-term rally in the Dollar? What would be the resulting price action of Energy, and more specifically, the price of oil?
Historically, Energy and oil prices are negatively correlated to the Dollar at -0.59 and -0.44, respectively. A rallying Dollar causes further decreases to Energy and the price of oil. This logic follows because the Dollar rally would lower global purchasing power, since oil is quoted in Dollars. Now, add in the possibility of another fall season COVID-19 lock-down, which will further depress economic activity and demand for oil - airlines, carriers and strategic stockpiles are not coming to the rescue - and the outcome appears consistent with expectation.
In summary, oil price uncertainty has presented, and will continue to present, significant financial challenges to enterprises with offerings highly dependent on oil. Some will be negatively impacted by these challenges because they have not hedged their exposure to lower oil prices. Others may be impacted because they have hedged at much higher prices and/or with sub-optimal strategies. If you decide to implement a prudent hedging program, this will allow you to preserve margin through what is sure to be an uncertain and volatile marketplace. To learn more, contact a HedgeStar advisor about how to integrate currency and commodity hedging programs into your risk management framework.
Contact the Author:
Johan Rosenberg, Chairman