The former French President, Valery Giscard d’Estaing labelled it the exorbitant privilege. He was referring to the prominent role the dollar has been playing in international trade ever since it became the world’s reserve currency after WWII. Its competitors, the euro, the yen, the pound and the renminbi also act in the capacity of reserve currency, but they pale in significance compared to the dollar – simply because it is the U.S. currency that is predominantly used in global trade. A strengthening dollar will push up the price of goods, including oil, in local currencies, acting as a break on demand growth and incentivizing production, depressing prices. A weaker greenback will stimulate demand outside the U.S. and hinder production/supply because prices in local currencies become relatively weak. It is price supportive for dollar-denominated commodities. This connection is displayed on the chart above.

It is noticeable that the Ukrainian war has upended the dollar/oil relationship, but daily data suggests that the status quo is being re-established. The question, therefore, is what the expectations are for the dollar exchange rate in the medium-term future. The voices of those who are betting on the greenback having found the top is getting louder. The consensus is that although inflationary pressure might last longer than expected it will be ultimately brought down, making the dollar’s “safe haven” status less attractive. Secondly, the Fed was the bellwether of the recent hike in borrowing costs, whilst other central banks reacted later to the rise in consumer prices. Consequently, the interest rate gap between the U.S. and other developed economies widened to record levels helping the greenback rally to generational highs. This trend is expected to reverse, the gap to narrow and the dollar to weaken. And if this is the case an additional layer of price supports will be created for oil. Of course, the price of oil is impacted by several factors and the dollar exchange rate is only one of them, nonetheless, it is a salient one.

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