Commodity prices and the US Dollar

Summary

Focus 

In the aftermath of the Covid-19 pandemic, rising commodity prices went hand in hand with a stronger US dollar, reversing the usual relationship between these variables. US dollar appreciation increased the inflationary effects of higher commodity prices for commodity-importing economies, and dampened the "shock-absorbing" effects of exchange rate movements for commodity exporters. This paper examines whether the post-pandemic correlation patterns between commodity prices and the US dollar will become more common in the future.

Contribution 

This paper sheds light on the relationship between commodity prices and the US dollar. It explores the links between this relationship and the evolution of the US terms of trade – the ratio of US export prices to US import prices. And it provides a novel interpretation of the so-called "commodity currency" relationship between the terms of trade and exchange rates of commodity-exporting small open economies.

Findings 

Post-Covid correlation patterns between commodity prices and the US dollar will become more common in the future. There is a robust and significant long-run relationship between the US dollar and the US terms of trade. In the past, when the United States was a net commodity importer, higher commodity prices corresponded to a lower US terms of trade and a weaker US dollar. Now that the United States is a commodity exporter, higher commodity prices raise the US terms of trade and strengthen the US dollar. "Commodity currency" effects for commodity-exporting small open economies will be correspondingly weaker.

Abstract

In the aftermath of the Covid pandemic rising commodity prices went hand-in-hand with a strengthening US dollar. This was a sharp contrast to the usual relationship between commodity prices and the dollar. This paper presents evidence that post-Covid correlation patterns could become more common in the future. This conclusion rests on two observations. First, the US dollar exhibits a close and stable relationship with the US terms of trade. Second, the United States' shift from being a net oil importer to a net oil exporter means that higher commodity prices now tend to raise the US terms of trade, rather than lowering them. Changes in the relationship between commodity prices and the US dollar will have implications for commodity exporters and importers alike.

JEL Classification: C22, F31, F41

Keywords: Time series models, foreign exchange, open economy macroeconomics