The price of oil had a remarkable comeback during the COVID-19 pandemic. After the initial selloff on the back of a sudden drop in demand, the crude oil price rose back to the breakout point and beyond.
It reached $68 last week, having the best start of a new year in more than three decades. More impressively, the move higher came with no pullbacks, no corrections, just a relentless push to new highs.
Until last week. For the first time after the price of oil settled below zero in 2020, it dropped 10% in just a few days. More precisely, most of last week’s drop took place in one single trading day.
What caused it and should we expect more of the same?
Oil and Risky Assets – A Tight Correlation
Any trader knows that there is no economic recovery possible if there is no demand for oil. Despite increased awareness about climate change and the negative effects of using fossil fuels, the world’s energetic needs depend on oil.
As such, the rise in the price of oil came on the back of increased optimism on the economic recovery. The more the confidence increased, the higher the price of oil, and the higher the risky assets. In financial markets, the risk is associated with the stock market, while safety to the bond market.
The big question this week is to see if the move lower in the price of oil continues? If it does, the spillover effects to the equity market should be noticeable, with ripple effects to other markets as well.
Have a look at the chart above. It shows what the fall in the crude oil price triggered last week. With the exception of precious metals, led by gold, all other commodities fell sharply.
A further drop in the price of oil should trigger something similar. With it, the commodities currencies, represented by the AUD and CAD, should come down from their highs too.
The most interesting thing is that no one could attribute the fall in the price of oil to anything else but fears of a stronger U.S. dollar. After the Fed’s press conference from last Wednesday, the dollar quickly turned higher and erased the temporary losses seen during the press conference.
Higher yields on long-term bonds fuel a higher dollar, and the trend may accelerate further. Last week’s drop in the price of oil happened in the last two trading days.
Will we see something similar this week?