HomeContributorsFundamental AnalysisRising Oil Prices Give Off a Foul Smell

Rising Oil Prices Give Off a Foul Smell

Released yesterday, the European services PMI data came in softer than expected in all major euro area locations. The data showed that services sector in Italy and Spain slipped into the contraction zone in August – a month of big summer holidays where people flock to Italian and Spanish cities and beaches. The soft PMI data fueled the European Central Bank (ECB) doves and pushed the EURUSD under a bus yesterday; the pair fell to the lowest levels since the beginning of June and flirted with the 1.07 support on idea that the ECB can’t raise interest rates next week when the economic picture is souring at speed. But I believe that it can. The ECB can announce another 25bp hike when it meets next week, or a faster reduction of its balance sheet, or the end of remuneration of banks’ minimum reserves to tighten financial conditions, because the latest inflation figures from the Eurozone showed stagnation, instead of further easing, and the ECB will allow economic weakness to some extent to fight inflation. The most recent inflation expectations in the Eurozone showed that the next 12-month expectations remained steady at 3.4%, but the three-year inflation expectations spiked to 3.4%, and there is no reason for inflation expectations to continue easing when energy prices are going up toward the sky.

More cuts

Brent crude rallied past the $90pb yesterday, as US crude advanced above the $88pb mark as Saudi Arabia and Russia announce that they prolong their supply cuts. Saudi Arabia will continue reducing its own unilateral supply by 1mbpd to the end of the year, while Russia will be cutting 300’000 bpd. The kneejerk reaction to the news was a sharp jump in oil prices but the news was not a shocker per se, investors knew that something was cooking. What surprised the market, however, is the timeline: cuts are announced for another 3 months.

The million barrel question now is: is $100pb back on the table? It’s unsure, and the road that could lead crude oil prices toward the $100pb psychological mark will likely be bumpy, because higher energy prices have already started being reflected in inflation and inflation expectations. As a result, the central banks, including the Fed, will have little choice but to keep their monetary policies sufficiently tight to prevent an uptick in inflation. That could mean further rate hikes, or keeping the rates at restrictive levels for longer, in which case, oil prices make a U-turn and cheapen due to recession and global demand concerns.

And when global demand worries kick in, and prices cheapen, Saudi will be losing money considering that the kingdom is shouldering the supply cut strategy for OPEC alone. For now, the demand outlook remains strong despite the slowing China and suffering Europe, but if it weakened, Saudi could easily change its mind, and the kingdom has a history of making sharp U-turns on its decision when winds turn against them.

‘Hell of a good week of data’

Interestingly, higher oil prices don’t seem to bother some Federal Reserve (Fed) members. Christopher Waller said at a CNBC interview yesterday that last week was a ‘hell of a good week of data’ which will allow the Fed ‘to proceed carefully’ with its next decisions. ‘We can just sit there, wait for the data, and see if things continue’ he said. They could also pray while waiting for the data to deteriorate, as higher energy prices won’t be any less problematic for the Fed.

Anway, both the US 2-year and 10-year yields jumped yesterday, because many companies flooded the market with debt sales. The US saw $36bn bond sales yesterday, the highest ytd. The S&P500 fell 0.42%, while Nasdaq eked out a small gain as Tesla jumped more than 4.5% on news that its China-made EV deliveries rose 9.3%, comforting investors that the price cuts in China may be playing in favour of the company.

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