Crude oil delivery trades narrowly with a soft tone in Asian morning. Traders decide to take a look at the fundamental after being driven by market sentiment in the past month. With OPEC unlikely to cut production further at the meeting on May 28, the market worries the abundant supply will dampen oil's recent rally. The Jul contract retreats to 60.93 after briefly rising above 62 yesterday, the Exchange will combine today and yesterday's trading for settlement purposes as US market was closed yesterday.

Recently, we have observed that correlation between oil price and EUR/USD, which collapsed after the bankruptcy of Lehman Brothers in 2008, has risen a lot. We believe this phenomenon has important implication on the dollar's movement. The causal relationship between oil price and EUR/USD runs from both directions. Lower USD will increase the purchasing power of oil from non-USD countries while investors sometimes buy oil in order to hedge against depreciation of USD and inflation. On the other hand, as US is the largest oil consumer in the world, high oil has bigger impact in the US than Europe.

The chart below showed that correlation between oil price and EURUSD surged in the middle of last year and peaked at around 3Q08. During that time, the theme that emerging economies will decouple from US' slowdown was still very hot and this might be the reason for rise in oil price and the euro (or decline in USD). We believe recent increase in correlation was driven by the theme that China-led recovery should lead the world out of recession, together with concerns about US' massive inflationary QE policies(which is negative for USD). It's true that apart from the US, many other central banks and governments have adopted monetary and fiscal policies in order to revive growth, the unprecedented package employed by the US as well as its dominant status as the world's reserve currency make it vulnerable to sovereign risk. Although it's not likely for US' rating to really be downgraded, any unfavorable comments would trigger massive selloff in the nation's currency.

Talking about inflation and USD, we have been saying recent rally in gold has been driven by renewed weakness in USD and rising inflation expectation. The chart below shows that inflation expectation does affect gold price movement but the impact was strong in mid-January to mid-February and has picked up again recently.

Although gold's strong movement has eased after soaring to 964.6 last Friday, trading momentum remains upbeat and rise should resume after USD's recovery completes.