Will Oil & Major Asset Correlations Return to 2022 Highs?

Oil prices are coming back into macro focus, as prices get back to multi-month highs. Interestingly though, correlations between oil and other major macro variables are clustered at low levels and are well down on 2022 highs.

• The chart below plots the rolling 3-month correlation between Brent crude prices and other major variables - global and EM equities, the DXY and USD NEER and US 2yr and 10yr yields.
• Correlations peaked around late March (in an absolute sense), after oil spiked above $120/bbl on numerous occasions. Higher oil prices were positively correlated with US yields and broad dollar performance and negatively correlated with global and EM equities.
• Can we see a repeat this time around? It is possible, higher energy prices could feed US inflation expectations, driving up Fed expectations, which sees renewed USD strength and weaker global/EM equities.
• However, there could be some important differences this time around. The headline shock of the Ukraine invasion is now behind us, at least to some extent. Fed tightening expectations are also much more advanced, while other central bank expectations have picked up, most notably the ECB, which can help mitigate USD strength.
• There is also perhaps greater potential for demand surprises to play a role, particularly as China emerges from lockdown. Whilst this will bias oil prices higher, all else equal, the market could view the latest oil bounce as less supply driven, at least compared to the March period. In turn this could see less fallout for risk asset sentiment.

Fig 1: Oil & Major Macro Correlations - Rolling 3 Month

Source: MNI - Market News/Bloomberg