FX & Y: The US petrocurrency illusion

America produces more crude than anyone. That does not spare it—or the dollar—the consequences of an oil shock.

A comforting narrative has taken hold in Washington. The shale revolution, which transformed America into the world's largest producer of crude oil, is supposed to have insulated the country from the geopolitical convulsions that have long roiled energy markets. Since the war in Iran was launched at the end of February, Donald Trump has repeatedly suggested that higher prices are to America's benefit, gesturing at the tankers loading up in American harbours as proof of the economic windfall.

In foreign-exchange markets, the dollar's traditional inverse relationship with crude has broken down; the greenback now often strengthens when benchmarks rise, and some have suggested that the greenback is becoming a "petrocurrency"*, acquiring a status previously held by units like the Canadian dollar and the Norwegian krone.

There is a kernel of truth in this. Over the past two decades, America's terms of trade have genuinely flipped. Higher crude prices now tend, on net, to buoy American export revenues. The country ships more hydrocarbons abroad than it imports, and when prices climb, the dollars flowing in outpace those flowing out. So far, so reassuring.

But the global oil market is indifferent to national narratives. Crude is a fungible commodity. When Brent moves, West Texas Intermediate moves with it. American producers, sensibly enough, sell to whoever pays the most—often foreign refiners. The result is that pump prices in Peoria remain tethered, however indirectly, to the decisions of a regime in Tehran and a president in Washington.

That tether has been yanking hard. Since the war began, American gasoline prices have risen sharply, punching past levels hit at a similar juncture after Russia’s invasion of Ukraine. They have also climbed more steeply than in most other large advanced economies, for a structural reason: America's lighter tax wedge allows crude's gyrations to pass through to consumers with brutal directness. In Britain, Germany and Japan, hefty fuel duties form a larger share of the retail price, helping dampen percentage-point swings over time.

This matters because in the US, consumer inflation expectations are strongly driven by prices displayed at filling stations. Few Americans track core personal-consumption expenditures, but everyone notices when topping up the tank costs twenty dollars more. The Federal Reserve, which sets rates in part to keep those expectations from becoming unanchored, is thus forced into a hawkish posture even as the broader economic imperatives point toward an easing in monetary policy.

Here lies the paradox. The very interest-rate differentials that might otherwise have tilted sharply against the dollar have held up, precisely because the Fed cannot afford to cut. Combine this with improved terms of trade and safe-haven inflows, and the dollar appears well-supported—creating the superficial impression that America thrives on expensive oil. In truth, the currency is being propped up in part by the unpleasant side-effects of a price shock the country was supposed to be immune to.

The dollar, in short, is not a petrocurrency. It is something more complicated: a currency that benefits from the monetary consequences of an oil shock that hurts its own consumers. That is a distinction with a difference: a non-linear surge in prices—of the kind that may now be coming into view—would almost certainly inflict more damage on the American economy than markets currently appreciate. A crude-driven rally in the dollar, far from signalling resilience, could sow the seeds of its own reversal.

- Karl Schamotta, Chief Market Strategist, Karl.Schamotta@Corpay.com

*Please note that the "petrocurrency" concept is—confusingly—distinct from the "petrodollar", which describes the recycling of oil exporter revenues into US financial markets. The Financial Times' Brendan Greeley penned an excellent (unfortunately paywalled) piece on the petrodollar over the weekend that is well worth reading.