Why the US Dollar Matters for Crude’s Next Move

The ASX 200 closed 1.5% higher to 5,239 points last week.

Our market surged on the back of resource and energy stock gains. Santos [ASX:STO] and Fortescue Metal’s Group [ASX:FMG] jumped around 11%. In other news, Qantas [ASX:QAN] shares crashed by nearly 16%. It announced plans to cut capacity last Monday.

With this in mind, the smart money’s heading across the Pacific.

The US Dow Jones surged above 18,000 points last week. This is a major psychological level, which hasn’t been hit since 21 July 2015.

The institutional money index closed at 18,003.75 points. It came close but couldn’t break through daily resistance of around 18,200 points. Keep your eyes peeled on that level. If it’s breaks, the Dow Jones could make a new high soon. Our market should respond favourably, if this happens.

What’s driving the market right now is earnings and oil’. That’s what Thomas Wilson, Managing Director of Brinker Capital, told investing.com. Brinker Capital is a multi-asset fund with US$17.7 billion under management.

I agree with Wilson’s comments…

Caution is advisable

According to investing.com: ‘77 per cent of first-quarter [US] earnings have exceeded expectations, which is superior to the 63-percent beat rate in a typical quarter’. This sounds like a good result. But is it really?

The US Dollar Index is down roughly 5% from its December high of US$100.51. The pullback helped grow US corporate offshore earnings. For example, looking at a lower greenback, it’s currently cheaper for us to buy US goods. When this changes, US corporate earnings should weaken.

There may not be long to wait…

Most currencies around the world aren’t healthy. I wouldn’t touch them.

The euro is an absolute disaster. Greece’s economy still hasn’t recovered from its bailout —and it will probably leave the Eurozone this year. Italian banks are riddled with bad debts. Deutsche Bank — Germany’s biggest lender — has shown signs of going under already. Adding it up, the euro is destined for new lows against the US dollar.

The Japanese yen is still a basket case. Abenomics, the policy package created by Japanese Prime Minister Shinzō Abe, is a total failure. It hasn’t stimulated the economy. The Bank of Japan is moving towards deeper negative rates. Making matters worse, it hinted at passing these costs onto deposit holders last week. If this happens, smart punters will move their money into the US, where there are positive interest rates.

The Australian dollar, Canadian dollar and emerging market currencies are all typically linked to commodities. In my view, which I’ve explained to Resource Speculator readers, the commodities bear market still hasn’t ended. This should hit commodities currencies in the months ahead.

Looking at the big picture, the US dollar is going higher…a lot higher. This will crunch US corporate earnings, potentially sparking a deeper stock market correction. If I’m right, crude oil’s current rally is unsustainable.

Digging into the facts

Nonetheless, let’s put the big picture aside. The combination of strong corporate earnings and oil’s outperformance has been good for stocks. Remember, Brent crude’s up roughly 64% from its 20 January low.

When the mainstream was extremely bearish on crude (which still hasn’t changed), I said it looked bullish on 1 March in Money Morning. Following this call, oil surged above technical resistance. I talked more about this topic on Friday. If you missed that update, here’s the punchline:

By the sounds of it, producers are looking to flood oil markets with more supply. Meanwhile, they’ll try and ‘create’ rumours that production cuts are back on the table. No doubt, they’ll tempt punters to buy into the rumour that the cuts will happen during the June [OPEC] meeting.

Reviewing the previous bounce, we could see crude jump into June. That said, I do have my doubts.

For now, the warning is clear: lock in your gains. It’s better to be safe than sorry. Remember, you can always buy your oilers back later, if crude closes above the March high next month.

Indeed, no market ever goes straight up — or down — forever.

Markets move in both directions. Smart investors understand this. After a massive rally, they tend to take the cautious approach. If they want, they can get back into the trade later. Or, not…

In my view, smart punters will be glad they sold and got short in the weeks ahead.

I’ll explain…

Forget fundamentals, follow central banks

In a world hooked on the next central bank move, I expect crude to head lower. For both this past week and the coming one, some of the world’s most prominent central banks are taking centre stage. Here’s actionforex.com, with a good summary:

This past week, the European Central Bank (ECB) was in focus. Not much about the ECB’s public pronouncements on Thursday was unexpected. ECB President Mario Draghi struck an overall dovish tone, reiterating the need to address persistent conditions of low inflation and economic growth risk. Overall, the central bank gave little in the way of concrete guidance for the euro aside from some dovish-leaning nuances, but the [euro] continued to fall into the end of the week.

Shifting to Asia, the end of [last] week saw the Japanese yen plunge against other major currencies as reports surfaced that the Bank of Japan (BoJ) is considering potentially more aggressive easing actions in the form of additional stimulus measures. This would entail the implementation of negative lending rates to financial institutions in Japan. Though the yen immediately began to plummet as the market digested this information. Therefore, the effectiveness of the BoJ’s easing tools and tactics has come into question.

This brings us to the most watched of major central banks, the US Federal Reserve. [This] week brings the potentially pivotal policy decision and statement from the Fed, in the form of the FOMC Statement.

Largely due to the Fed’s increasing dovishness since December, the US dollar has been weakening steadily for the past few months, despite the prevalence of increasing dovishness across most other major central banks as well. As always, [this] week’s statement will be scrutinized in minute detail for wording nuances that might indicate a dovish or hawkish bias. If the Fed continues its increasingly dovish progression, the dollar could extend its weakness of the past few months. Any signs of emerging hawkishness, however, could help to buck the downtrend.

Looking at the stronger US unemployment numbers and the bullish US stock market, I expect the Fed to release a hawkish statement. If I’m right, they’ll look at raising rates in June.

If this happens, the US dollar should scream higher in the months ahead. The probably won’t be good for crude, which is priced in US dollars. And, based on the high correlation, this may be bad news for the stock market — especially resource stocks. In this case, it’s best to be cautious for now.

If you want to know the best time to buy commodities, and the best miners digging them up, check out Resource Speculator. You can read more, here.


Jason Stevenson,
Resources Analyst

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