Ailing dollar softens Europe's hit from any oil shock
While oil-importing countries won't fully escape a hit in the event of another energy price shock on Middle East tensions, a period of rare dollar weakness will soften the blow considerably for countries outside America.
Most crude prices are denominated in U.S. dollars, so when jumps in the oil price occur during periods of relentless dollar strength, the pain is compounded for regions like Europe. This year's dollar swoon, however, has had the opposite effect, cushioning the impact of the oil price increase set off by the unfolding Israel-Iran war.
To be sure, we're still far from 'shock' territory. Dollar-based global crude prices have jumped about 14% since early last week, but they remain well below January peaks and about 7% lower year-over-year.
But the impact has been even more benign in Europe, due to the euro's 12% rise against the dollar in the year to date.
While the oil price in dollars has all but wiped out its decline for the year so far, the euro price of Brent crude is still down 12% in 2025 and is 20% lower than one year ago. "For oil-importing nations, the greenback's decline offers a crucial reprieve, helping to cushion the blow from soaring oil prices and to limit broader economic fallout," UniCredit strategist Tobias Keller wrote on Wednesday.
Should the dollar continue to weaken, it could mitigate the relative economic impact on Europe of any renewed energy price squeeze. That, in turn, could support Europe's performance versus the United States this year and further erode the American exceptionalism narrative fueling extraordinary portfolio flows to the U.S. in recent years.
What's more, ongoing dollar weakness amid a fresh energy price retreat would just load more pressure on the European Central Bank to cut interest rates to prevent a big undershoot of its 2% inflation target.
Increasingly unstable
The dollar/oil link is yet another example of a financial relationship that, in the words of UniCredit's Keller, has become "increasingly unstable" this year.
As foreign investors with trillions of dollars invested in U.S. stocks and bonds have started rethinking their dollar exposure in light of America's trade wars, re-worked alliances and upended domestic institutions, the dollar's correlation with stocks, bonds and commodities has shifted.
Most obvious is the greenback's apparent loss of its traditional 'safe haven' status during times of great uncertainty and stress, with the dollar falling alongside both stocks and bonds during a turbulent April.
The dollar/oil link has become particularly unstable.
All else being equal, a stronger dollar should weaken oil prices by sapping non-American demand around the world due to the added local currency cost of a barrel of oil. And the opposite should, in theory, also be true.
Yet the cause-and-effect was the other way around in recent years, as a spike in oil prices after Russia's 2022 Ukraine invasion spurred inflation and steep Federal Reserve interest rate rises, followed by a subsequent decline in oil prices and inflation and the beginning of a Fed easing cycle.
During that series of events, the dollar moved broadly in tandem with energy prices. When the oil price doubled between mid-2021 and the immediate aftermath of the Ukraine invasion, the dollar index surged by 20%, magnifying the impact of rising energy costs for Europe and elsewhere.
But that relationship broke down again last year after the U.S. election, as the dollar initially climbed even as oil prices fell.
While the positive correlation resumed after January, the surge in crude this month after the Israel-Iran war broke out has not been matched by a strengthening dollar. Indeed, the greenback is still flirting with new lows.
The relationship depends on the backdrop of course. Right now, the primary concern is that a decade of relentless dollar strength now faces a multi-year unwind as trade, economic and investment imbalances are forced to correct.
If that prevails, any renewed oil spike would be less severe than last time for the global economy at large.
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