Monday, August 18, 2008

Oil, dollar and interest rates

I had thought in April that commodities will weaken as Fed ends its interest rate cut campaign, because that will support dollar. That didn't happen. Then I thought that probably Fed needs to hike interest rates to make dollar strong to kill commodities.

What has happened is different. Expectations on Europe have changed from rate increases to rate cuts. So the expected interest rate differential between dollar and Euro has narrowed, strengthening the dollar and weakening commodities. A valuable lesson. Relative interest rates are more important than absolute interest rates in the forex market, and by extension commodities.

There is a clear linkage between credit crunch and commodities through interest rates and forex moves. A lot of people think these are two seperate problems. They are not. All these demand-supply theories on commodities are BS in the short run, and not enought to explain oil prices going up from 100 to 145 in 3 months.

This is another evidence of the point made by Charles Kinderberger in "Manias, Panics and Crashes" - asset deflation moves from asset class to asset class and country to country - often through capital market linkages. Oil price spike caused by credit crunch has made sure that emerging markets weaken significantly.

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