The movements in oil prices and the United States dollar exchange rate, and the relationship between the two, are major determinants of fiscal policy, domestic growth, inflation, and, in turn, monetary policy. Over the last several decades, oil prices and the US dollar have moved in opposite directions, providing a necessary relief valve from fiscal pressures, particularly for emerging market oil-importing economies.

Recently, this negative correlation in the oil-dollar relationship has reversed. Oil prices and dollar value have moved together in a positive direction for the last few years, a linkage which may herald a new (and potentially more volatile) era. Positive co-movements of rising oil prices and dollar appreciation can significantly impact the economic fortunes of oil importers — a dynamic that is not fully priced into markets.

In this paper, we examine the reasons for this change in correlation and explore whether the recent reversal is cyclical or structural. Our analysis shows that the role of the US as a major oil exporter, and the associated impact on US terms of trade, is likely exerting stronger (and causally determinative) pressure on dollar movements. This is a significant development that warrants further monitoring.

We also examine the implications of this dynamic becoming structural for fiscal and monetary policy of oil-importing economies and, importantly, for client portfolios with exposure to oil-importing economies. Finally, we suggest ways in which clients can seek protection against this unpriced risk.