Oil and inflation are closely tied. So much so that economists exclude the volatility of energy and food and create the CORE inflation metrics. As traders are focused on supply and demand which is being driven by the COVID-19 and its variants, we also must acknowledge that it can all be turned on its head by an outlier CPI reading this Friday.
Commodity Analysis - oil
Gold's relative performance versus other asset classes is highlighted by the World Gold Council's latest monthly report. During periods of high inflation, US treasuries outperformed the conventional wisdom that gold is a great inflation hedge. In terms of investor returns, oil is by far the largest winner on this list, while the Japanese yen is quite understandably the weakest.
The US dollar has also been on the rise as the Federal Reserve is keen to tighten monetary policy in the hope of cooling the overheating market. At some point, I would imagine a higher valued US dollar would have some negative impact on the price of oil but that would also rely on there being a balanced to the over-supplied energy market. In this week's oil futures market, investors were buoyed by reports that the Omicron Coronavirus variant only exhibits mild symptoms, so demand may also be on the way back after a little setback.
Following last week's OPEC+ meeting, there will be an increase in production of 400k BPD from January, much to the delight of the USA. The price of oil is rising even with the proposed coordinated SPR releases and output increase by OPEC+, which indicates that fundamentally we're still in a tight market. In the current quarter, OECD inventories are likely to fall below 2.8 billion barrels, which corresponds to oil prices over $80, based on the pre-Omicron level.
The ActivTrades sentiment indicator shows that retail traders on the trading platform are overall bullish oil, though these bulls have been slipping out of the WTI contract. If this cohort were to turn overall bearish for some reason, I would expect to see higher prices sooner. As it is, I am looking for technical areas to look for a short to squeeze the remainder of retail traders out.
Omicron won't go away, and who is to say a new more concerning variant or variants won't appear soon. Omicron is spreading across multiple regions in the United Kingdom and could become the dominant variant in the next few weeks. To lessen the negative health impact of the fourth wave, a red travel alert has been issued for various countries, and we are seeing cases rising sharply in some parts of Europe. France is closing nightclubs for four weeks. If Christmas gets canceled this year, I imagine 2022 will start off very gloomily.
The recovery from the pandemic-induced destruction combined with the shortage of everything resulted in an unforeseen increase in inflation since both consumer and producer prices rose faster than expected. The chart above from the US Bureau of Labor Statistics shows the magnitude of rising Energy inflation.
The growing Omicron concern has started to weaken the inflation story, yet the Fed decided to accelerate its move to withdraw monetary stimulus and potentially scale back its bond-buying scheme faster than previously announced. More FOMC members are calling for speedier tapering. The idea is, that faster tapering will result in a faster rise in interest rates. The intended result? borrowing will be hindered, thereby reducing economic growth, and subsequently reducing oil demand.
The bounce seen in the daily chart looks impressive but we’re about to run into some serious resistance. $77 per barrel will be a crucial line to get back above, though not until $82 does the market structure look bullish again.
Both the Brent and WTI intraday charts show prices rebounding off a previous supply zone. There is also a possibility that the rising channel that has been carved out since the beginning of December could break to the downside.
This Friday we receive the latest US CPI figures and having seen oil drop from the year's highs in October in line with the rising US Treasury 10 year, it will be interesting to see where we end up at the close on Friday.
If CPI comes in higher than expected the US 10-year notes will drop and we could predict that the price of oil will rise based on the recent price action seen in the chart above. If the US CPI comes in under expectations and the US 10-year notes rise as traders move out of a sooner rather than later rate hike mindset, the price of oil may be allowed to fall.