[Below is a brief excerpt from a commentary published at www.speculative-investor.com on 22nd December 2024]

Interest rates are always among the most important determinants of currency exchange rates, but over the past two years they have dominated. We cite the following two charts as evidence.

The first chart compares the US$/Yen exchange rate (the black line) with the yield on the US 10-year T-Note (the green line). This chart only illustrates the strong positive correlation between these two markets over the past two years, but the relationship has existed and has been tracked at TSI — normally via a chart that compares the Yen with the price of the 10-year T-Note — for much longer.

The second chart compares the Dollar Index (the black line) with the yield on the US 10-year T-Note (the green line).

These charts show that over the past two years the US$ has strengthened against other fiat currencies whenever the US 10-year T-Note yield has risen and weakened against other fiat currencies whenever the US 10-year T-Note yield has fallen. The relationship operates on a trend basis rather than a daily or weekly basis, although it was evident last Friday when a slightly lower-than-forecast Personal Consumption Expenditures (PCE) Index prompted a dip in the T-Note yield, which, in turn, prompted a pullback in the US dollar’s exchange rate.

The overarching message being sent by the above charts is that for the US$ to continue strengthening, the US 10-year T-Note yield will have to continue trending upward. This is unlikely, because we probably are now seeing a sentiment peak related to the expected inflationary effects of Trump’s policies, US economic strength, US stock market outperformance and Federal Reserve ‘hawkishness’. What we haven’t seen yet are any signs in the price action that the trends of the past 2-3 months have ended.

[This blog post is an excerpt from a recent commentary published at www.speculative-investor.com]

The phrase “Drill baby drill” has been around for a long time, but Trump embraced it during his recent campaign to describe the approach to drilling for oil that would be taken by his administration. What will be the likely effect on the oil price of this approach to oil industry regulation? The short answer is: The effect probably will be minor. For a longer answer, read on.

One reason that the effect of this new approach won’t be substantial is that for all its words to the contrary, the Biden Administration did very little to hinder oil drilling. Therefore, the Trump Administration’s “Drill baby drill” approach will not constitute a major change.

The second and most important reason is that in the absence of regulatory roadblocks the actions of the oil industry will be determined mainly be the oil price. It’s reasonable to expect that drilling activity would ramp up if the oil price were to make a sustained move above $90/barrel, but it’s also reasonable to expect that drilling activity would be slowed if the oil price were to make a sustained move below $60/barrel. Therefore, Trump’s opinion that in the absence of regulatory obstacles the oil industry will drive the price down to very low levels is not plausible.

The reality is that although the oil industry is notoriously undisciplined, due to what transpired over the past ten years the one thing that will instil discipline in the future is a low oil price. In the future, an oil company CEO who continues to expand, or more likely fails to cut, production in response to sustained weakness in the oil price probably won’t keep his/her job.

It’s therefore likely that the future response of US-based oil producers will act to keep the oil price in a wide range. That is, it’s likely that in the absence of other influences the future supply response of the US oil industry will create both a ceiling and a floor for the oil price.

Of course, there will be other influences, one of the most important of which will be the actions taken by OPEC+. OPEC+ has about 5 million barrels/day of spare capacity that could be brought on line relatively quickly and cheaply. This represents a bigger threat to the oil price than the “drill baby drill” policy in the US.

In all likelihood, OPEC+ will act similarly to the US oil industry and only increase its production in response to a sustained rise in the oil price to a much higher level. However, there are plausible scenarios under which OPEC could ramp-up its production despite weakness in the oil price. It has done so in the past with the aim of creating financial problems for its competitors in the West and forcing these competitors to reduce production. It could do so again for this reason or because the Saudi leadership does a deal with the Trump Administration that involves guarantees of security/weapons in exchange for a price-suppressing boost to oil production.

Our view at this time is that a much higher oil price is a realistic possibility for 2026-2027, but that the oil price will spend the next 12 months in the $60-$90 range. Furthermore, whereas it probably would take a war-related supply disruption to push the oil price well above the top of the aforementioned range, a move to well below the bottom of the range could result from either OPEC ramping-up production for the reasons mentioned above or a severe recession.