Oil's Rebound Is Quietly Feeding Inflation Fears and a Firmer Dollar

Currency markets tend to be framed as a contest between central banks, but oil has a way of writing itself into the story. Oil prices and the dollar are moving in the same direction, as a rebound in West Texas Intermediate crude feeds U.S. inflation concerns, lifts Treasury yields and helps keep the U.S. dollar at a two-month high. That matters well beyond the energy market, because it lands on top of hawkish Federal Reserve signals and a Bank of Japan that has struggled to support the yen. The result is a dollar with more than one engine behind it, and a yen that has weakened more than 3% in just two weeks.

Fiona Cincotta, StoneX Senior Market Analyst, has more than 15 years of experience trading and analyzing U.K., European and U.S. markets, combining fundamental and technical analysis. Her coverage spans forex, commodities and equities, tracking how macroeconomic data, energy prices and central bank policy feed through to currencies such as the U.S. dollar and the Japanese yen.

Key Themes

• A rebound in West Texas Intermediate crude is adding to U.S. inflation concerns and lifting Treasury yields.
• October Federal Reserve hike odds jumped to 75% from 50% after the strongest U.S. composite PMI in over five years.
• The Japanese yen has weakened over 3% in two weeks despite a Bank of Japan hike to a 31-year high.

Watch the Full Video

Oil Rebound Lifts U.S. Inflation Concerns, Treasury Yields and the Dollar

"That's also supporting these inflationary concerns, lifting yields and keeping the dollar at a two-month high," Cincotta says of the recovery in West Texas Intermediate crude. A rebound in oil prices is reinforcing U.S. inflation concerns at a moment when Federal Reserve speakers have backed the view that the Federal Reserve may need to hike interest rates several more times to bring inflation back to its 2% target. The energy signal arrives alongside a U.S. composite PMI at its strongest level in over five years, a reading that lifted market-implied odds of an October Federal Reserve hike to 75% from 50%. Meanwhile, the 10-year Treasury yield has pushed to fresh 19-year highs. For currency traders, the upshot is a U.S. dollar supported from several directions at once, with oil now part of the same inflation story as the Federal Reserve's own signals.

Yen Weakens as a Bank of Japan Hike Fails to Offset Rising U.S. Yields

The Japanese yen has weakened more than 3% in two weeks even though the Bank of Japan raised rates by 25 basis points to a 31-year high, because markets are not convinced further tightening is coming. Governor Kazuo Ueda, Cincotta explains, "failed to really convince the market that the Bank of Japan is aggressively looking to hike rates further", and the yen has slid as a result. Conversely, the Federal Reserve raised rates by 25 basis points and signaled two more hikes, a path that oil-driven inflation concerns only reinforce. That policy divergence is what is lifting USD/JPY, sending the pair back toward the zone traders associate with Japanese intervention. For anyone following the yen, oil has become an indirect but meaningful input, feeding U.S. inflation concerns and yields on one side of a policy gap the Bank of Japan has not convinced markets it will close.

 

--- Written by Gus Farrow, Senior Manager, StoneX Media

--- Expert: Fiona Cincotta, StoneX Senior Market Analyst