Higher prices are supporting the US dollar, and the recent rise in commodity barrel prices poses big risks for those who see the US currency weakening globally towards the end of the year. Bank of America (BofA) said in a statement sent to clients and the market on Wednesday.
“We argue that policy responses to inflation are likely to have amplified the positive impact on the US dollar from recent supply-driven oil shocks,” the bank said in a paper.
“Over the longer term, the positive impact of oil prices on US terms of trade could mean more sustained upside risk for the US dollar,” added currency strategists John Shin and Alex Cohen.
The nature of the oil supply shock, which the bank says has more to do with supply conditions including the Russian invasion of Ukraine and concerns about turbulence in the Middle East, also supported the dollar, strategists said.
“High oil prices ultimately support US dollar gains, both through high inflation dynamics and supply shocks, typically also presenting an overall risk-off environment that encourages the dollar to strengthen,” they note, adding, that the Federal Reserve’s contractionary monetary policy helped increase the impact. The bank recalls that during previous episodes of rising energy prices in 2008 and 2011, the Fed decided to assess the inflationary impact, but the European Central Bank (ECB) raised interest rates, which also led to a rise in the euro.
The bank’s strategists believe that while the nature of the shocks may be temporary, “oil is likely to remain a broadly positive force for the dollar overall due to the changed relationship with the U.S. economy, barring cyclical surprises,” given the benefit from this increase in U.S. terms of trade .
BofA sees the dollar weakening over the medium term, with an end-of-year forecast for the pair at 1.15, expecting US interest rates to fall, but warns of risks for the dollar to rise in the face of high oil prices.