Strong dollar creates powerful commodity market trends
These days financial markets are more inter-connected than ever. Many active equity traders keep an eye on the big moving energy stocks. But, if you are an individual trader trading say energy stocks, it is almost imperative to keep an eye on the U.S. dollar.
Why? Most commodities, including crude oil, are priced and sold in U.S. dollars on the world marketplace, which means that if the dollar strengthens, that makes it more expensive for foreign buyers to purchase crude oil, or U.S. wheat or even gold. Generally speaking there is an inverse correlation between commodities and the dollar. As the dollar rises, these commodities tend to fall.
Figure 1 below shows a rising trend in the U.S. dollar and an inverse falling trend in Nymex June crude oil futures.
The strength in the dollar is big news right now. One of the major factors driving the U.S. dollar higher is foreign capital flows into the U.S. currency. While other major global central banks, such as the European Central Bank and the Bank of Japan are still implementing extraordinary easy monetary policies including active asset purchase programs, the U.S. Federal Reserve is expected to hike interest rates this year.
In the currency markets, capital flows follow the path toward higher interest rates, and in 2015 currency traders expect U.S. rates to beat out those of other advanced industrial nations, so money flows into the dollar.
The U.S. dollar has surged to 12-year highs against some of the major world currencies and this reverberates in many ways. Here are a few to consider.
Rising dollar imports lower prices.
The strength in the U.S. dollar translates into cheaper imported goods for Americans, while in turn making imports more expensive for those overseas. The rising dollar could throw a wrench into the Fed's plans to hike interest rates this year due to its dual mandate of both full employment and stable inflation. The U.S. economy is having trouble mustering enough inflation to hit the Fed's 2% target mark.
Slashes profits for U.S. multinational companies.
For big U.S. companies that sell consumer items, technology, pharmaceuticals and much more abroad, when they bring their profits back home the value of their profits is reduced by the strength in U.S. dollar.
Inverse correlation with many commodities.
Last but not least the strength in the dollar is showing up as a strong influence across many commodity markets including crude oil, gold and wheat to name a few.
The trend is your friend.
The dollar can be a directional clue for many financial markets. The strong trend in the dollar in turn can create strong trends in commodity markets. You've all heard the saying: the trend is your friend.
Powerful trends across commodity markets offer unique and potentially profitable trading opportunities. For stock traders who haven't considered futures, now might be the time to take a look.