Dollar May Begin to Crumble Under Crude Oil's Downward Pressure

(Bloomberg) -- The dollar’s 2018 rally may begin to see cracks as oil’s plunge signals a possible top.

For the most part, the greenback has weathered oil’s slump, in part due to a return of the dollar carry trade. But Mark McCormick at TD Securities says the U.S. currency may be at a peak since the U.S. economy could take a hit from oil’s abrupt slide to the lowest since last year.

“The past few months the USD has benefited from a US-based carry trade, which rested on low volatility and relative outperformance,” TD’s North American head of FX strategy wrote in a note Wednesday. “The collapse in oil matters in this case since the US is now one of the notable (global) marginal oil producers. It is a growth shock to one of the US’s key growth industries.”

The slump in crude is likely to weigh on the U.S.’s “already challenged” economic outlook and may accelerate a recent trend of investors reallocating investments into money-market instruments, a likely sign of dollar weakness, Morgan Stanley strategists including Hans Redeker wrote in a note. The currency’s inverse correlation to oil should turn increasingly positive over time, they wrote, and they are adding to the short dollar position in their portfolio.

West Texas Intermediate has tumbled almost 30 percent since early October. With crude and stocks sinking, and policy makers citing concern about potential headwinds to U.S. economic growth, traders have trimmed expectations for Federal Reserve rate hikes in 2019.

Ten-year Treasury breakevens, which represent investors’ view on the annual inflation rate through 2028, have slid below 2 percent for the first time since January alongside the slump in crude.

To contact the reporter on this story: Austin Weinstein in New York at aweinstein18@bloomberg.net

To contact the editor responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net

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