DOLLAR FEARS MAY KEEP OIL ON THE BOIL

 
David Morris
FINANCIAL markets initially reeled following last week’s announcement from Standard & Poor’s (S&P). The ratings agency downgraded its outlook for US sovereign debt to “negative” from “stable”, implying a 33 per cent chance that the US would lose its AAA credit rating within the next two years. The agency is concerned by the fiscal challenges facing the US and warned policymakers to address the situation immediately rather than waiting until after the presidential election in 2012. Many analysts shrugged off S&P’s warning either by attacking the credibility of the agency or by insisting that it is overreacting to old news. But the downgrade highlights the danger to the US economy of the current political impasse.

Investors are already worried about what will happen to financial assets once the Federal Reserve ends its programme of asset purchases this summer. On top of this, the geopolitical and macroeconomic outlook is still a concern. Violence continues to flare up across north Africa and the Middle East; Japan is still struggling to deal with its nuclear crisis and supply chain issues; Europe is hampered by its debt problems, and inflation is on the rise everywhere leading to interest rate hikes in the Eurozone, as well as China and other emerging countries.

Firmer oil prices are also playing into this mix. Just a few weeks ago, crude hit its highest level since the summer of 2008. It then pulled back sharply following a number of “sell” recommendations from Goldman Sachs, which cited weaker global demand, a possible ceasefire in Libya and excessive long-side speculation. Crude has since rebounded and made back around 50 per cent of its losses. Then last week’s S&P downgrade hit prices again as the US dollar rallied on a “flight to safety”, but support has held at $121 for Brent and around $106 for the WTI contract. The oil price should be self-correcting to some degree. While higher prices hurt global growth and stoke inflation, they also put a dent in demand. But it’s the dollar that currently holds the biggest influence over oil. With the Federal Reserve determined to complete its $600bn of asset purchases, and as US policymakers struggle to control the budget deficit, the dollar should remain under pressure. This should ensure that oil prices are kept on the boil.