The bullish rise in commodity prices is facing stiff resistance from the strengthening dollar. Prices of oil, metals and agricultural products have fallen since early June, after rising after the Russian invasion of Ukraine. The recent decline reflects, among other things, investors’ fears that a recession is around the corner, and that it will hurt demand. But another reason is the fact that most goods are priced in dollars. This means that the strengthening of the dollar makes them more expensive for buyers around the world, and hurts demand.
Encouraged by the Federal Reserve’s interest rate hikes and concerns about the global economy, the dollar has climbed to its highest level since 2002, according to the Wall Street Journal’s dollar index, which examines the value of the green note against a basket of other currencies. Hardly anyone thinks the Fed will stop during its interest rate hikes until next year.
“If oil is expensive in dollar terms and the dollar strengthens, it will become even more expensive (for anyone holding other currencies),” said Giovanni Staunovo, an analyst at UBS Global Wealth Management.
Will the pressure on commodity prices moderate inflation?
When these dynamics continue, and commodity prices remain under pressure, it could help lower inflation, saving the Fed the need to raise interest rates so quickly and so sharply that it could tip the U.S. economy toward recession.
Consumers are already feeling some relief. Commodity sales panic has lowered gas station prices, prompting some investors to hope that consumer price inflation peaked in June.
Data on vehicle and aviation use give little indication that fuel demand has declined at major importers such as China and India, said Damian Korblan, director of energy research at Goldman Sachs. But that is likely to change as higher prices weigh on consumers.
Goldman estimates that the strengthening of the dollar has raised fuel prices at stations in countries like India, on the order of $ 10 a barrel. The inability to independently refuel crude oil adds another $ 15 a barrel, according to Goldman Sachs calculations.
The International Energy Agency announced this month that the strength of the dollar, along with the peak in refined fuel prices, are expected to hurt demand for oil in emerging markets. When the price of Brent crude oil peaked in early June, its price was 59% higher in dollar terms. But in terms of the Chinese yuan, it rose by two-thirds, and by Japanese yen, by 85 percent.
A stronger dollar not only adds to the cost of purchasing raw materials outside the U.S. It is also expected to encourage non-US commodity producers to get rid of inventory, as their profits become larger after converting to local currency.
The strengthening of the dollar makes it difficult to import products
The raging dollar is making it difficult for some countries to import products. In Argentina, for example, a shortage of American currency has led the government to issue fewer import licenses for coffee, said Carlos Marra, an analyst at Rabobank. “There is a fear that coffee will become a rare commodity in the country,” he said.
The relationship between commodity markets and currency is complex. Historically, raw material prices have been inversely related to the U.S. currency, meaning that when the dollar rose they fell, and vice versa.
This is not just because a stronger dollar is hurting demand. As for copper and grain, workers’ salaries and other inputs are mostly paid in local currencies. So production costs go down as currencies like the peso of Chile or the Canadian dollar weaken.
In terms of oil, the picture has become more complex in recent years, after the oil shale revolution turned the U.S. into a major exporter of energy, and as oil-producing countries in the Middle East began to convert more than their dollars from oil production into U.S. assets. Oil prices just as the dollar began to soar.
The negative ratio between oil and dollar prices returned to the picture in June. The price of a raw Brent barrel fell by 14% from its peak on June 8, to about $ 106 per barrel. During this time, the Wall Street Journal’s dollar index rose 3.8 percent.
At the same time, the fear of a recession is causing investors to reduce gambling on commodities, including oil and copper, said Caroline Bain, a commodity economist at Capital Economics. They purchased these goods in quantities earlier this year as a hedge against inflation, Bain added.