Correlations we got used to are changing, and this is significant. What does it mean to for the dominant dollar? Here is the view from Deutsche Bank:
Here is their view, courtesy of eFXnews:
Something strange is happening in markets. While the dollar and the oil price have historically moved in opposite directions the correlation has suddenly flipped positive: a higher oil price is helping the dollar rally and vice versa (chart 1).
Is this sustainable? In many ways, it could be: Fed hawkishness was driving the dollar stronger against both currencies and commodities last year. This time round, the oil price rally is pushing US inflation expectations and US long-end rates higher.
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How important is this as support for the dollar?
For EM currencies reliant on unhedged local debt inflows it is critical: a US bear steepening driven by higher inflation expectations and bond risk premia is far more disruptive to EM FX than a slow Fed hiking cycle that keeps the US back-end stable.
For low-yielding G10 FX like the EUR and JPY, we’re less convinced that the current rate re-pricing is a material dollar support. Both currencies are more sensitive to short-end real rates, in turn, reliant on a hawkish Fed and/or better US growth data. Either of which has yet to happen, with the recent re-pricing of US breakevens pushing EUR/USD “fair value” on real rate differentials higher to 1.10, not lower. Our yearend forecast for EUR/USD is 1.05, but we are a little cautious that rising oil prices and US breakevens may not be sufficient to get us there.
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