The Dollar Is Trading Like a Petrocurrency

The U.S. is now the world’s top crude oil producer, and higher oil prices increase global demand for dollars, causing the dollar to trade in lockstep with oil since the Iran war began.

Since the Iran war began three weeks ago, financial markets have behaved in a highly confusing and counterintuitive manner. One example is the strength of the U.S. dollar, which has weighed on precious metals. In this report, I explain why the dollar and crude oil have risen in tandem, emerging as the primary beneficiaries of the war so far, and what to expect going forward.

Let’s start by taking a look at the U.S. Dollar Index, which measures the dollar’s exchange rate against other major currencies. Please note, however, that it does not measure the dollar’s purchasing power.

Since late January, the U.S. Dollar Index has been rising, which has been a major reason for the pullback in precious metals. This is because the dollar and precious metals have an inverse relationship, with dollar strength typically being bearish for precious metals and vice versa. The Dollar Index received an additional boost following the start of the U.S.-Israel war on Iran in late February.

It may not be obvious or intuitive why the dollar would strengthen following a U.S. attack on Iran, but I will explain what is happening so that it makes more sense. While many people do not know this, in recent decades the U.S. has become the world’s top oil producer, and as a result the dollar has benefited from the surge in crude oil prices in recent weeks. Both West Texas Intermediate and Brent crude surged from the $60s to as high as $120, though they have pulled back somewhat since their March 9 peak.

The chart below shows that the U.S. Dollar Index and crude oil have been trading in lockstep since the war began: