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Sunday, November 29, 2015

Commodity Prices, Exchange Rates, and the Fed

Jim Hamilton's bottom line is worth noting:

Commodity prices and exchange rates: The dramatic decline in the prices of a number of commodities over the last 16 months must have a common factor. One variable that seems to be quite important is the exchange rate. ...
One would expect that when the dollar price of other countries’ currencies falls, so would the dollar price of internationally traded commodities. But it is a mistake to say that the exchange rate is the cause of the change in commodity prices. The reason is that exchange rates and commodity prices are jointly determined as the outcome of other forces. ...
For example,... the Great Recession in 2008-2009 ... meant falling demand for commodities. It was also associated with a flight to safety in capital markets, which showed up as a surge in the value of the dollar. It’s not the case that the strong dollar then was the cause of falling dollar prices of oil and copper. Instead, the Great Recession was itself the common cause behind movements in all three variables. ...
I had been giving a similar interpretation to the correlation since June 2014 ... – news about weakness in the world economy seemed to be a key reason for strength of the dollar..., and would also be a reason for declining commodity prices.
However, developments of the last three weeks call for a different explanation. The October 28 FOMC statement and subsequent statements by Fed officials have made clear that a hike in U.S. interest rates is coming December 16. An increase in U.S. interest rates relative to our trading partners is the primary reason that the dollar appreciated 4% (logarithmically) since October 16. Over that same period the dollar price of oil and copper each fell 16%. ...
I will offer the view, based on the market reaction so far, that if the Fed’s objective in raising rates is to lower U.S. inflation and GDP, it seems to have taken a significant step in that direction.

[There's quite a bit more analysis in the full post.]

    Posted by on Sunday, November 29, 2015 at 10:02 AM in Economics, Monetary Policy, Oil | Permalink  Comments (19)


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