US crude plunged 4% yesterday, sinking below $70/bbl and Brent slipped below $75/bbl. Momentum traders and falling volumes exacerbated crude’s latest plunge, while OPEC’s latest production cut announcement and Saudi Arabia’s additional threats to extend its solo cut beyond Q1 went completely unheeded. Worse, as the bears have seen investors ignore the cuts and threats, they feel more confident to increase their bets against crude. And indeed, the cartel’s shrinking share of global production and frictions among members over the supply cut strategy mean that either the supply cuts won‘t make much difference or further action will be difficult and perhaps too costly.
Add to this the worries about the global economic slowdown, the dwindling interest in falling prices, and the lack of emotion in algorithmic trading about OPEC news, and you can see why a barrel of crude oil is below $70 a barrel this December and not above $100 a barrel, as many banks had predicted at the beginning of the year. And if a drop of more than 4.5 million barrels in U.S. oil reserves last week couldn’t stop yesterday’s oil selloff, it’s because the latest number was blurred by a huge margin error, the largest on record – or the bulls just couldn’t find the energy to swim against such a strong tide.
The question on everyone’s mind is: can crude oil extend its losses? At current levels, crude oil is trading close to oversold territory, so your algorithmic models based on market metrics should take this into account and slow the selling. As such, we will see some bounce at current levels. However, any bounce may remain limited to the $75/78 area, including the minor 23.6% Fibonacci retracement and the 200 DMA, and when the time is right, we may see this negative move extend to the $65/67 area.
There remains the question of the US strategic reserves, which the US is said to be considering replenishing between $67/72. Yes, this will certainly help slow the downside pressure at this level, but keep in mind that these buybacks are limited to about 3 million barrels per month due to physical constraints and won’t turn the tide.
Now that the OPEC risk is out of the way, the biggest upside risk for oil is tensions in the Middle East.
Too dovish
Falling energy prices are helping to soften global inflation expectations and keep central bank doves in charge of the market, along with sufficiently soft economic data to point to the end of the global monetary policy campaign. This week, the Reserve Bank of Australia (RBA) and the Bank of Canada (BoC) kept interest rates unchanged – although the RBA said it could hike again if domestic inflation doesn’t slow.
But overall, the Federal Reserve (Fed) is expected to cut as early as next May, and the European Central Bank (ECB) is expected to announce six 25 basis point cuts next year. If that’s the case, the ECB should start cutting before the Fed, sometime in the first quarter. That sounds overdone to me.
Data released earlier this week showed that French industrial production unexpectedly fell for a third straight month in October, Spanish production declined, and German factory orders fell 3.7% in October versus a 0.2% increase that analysts had forecast. The slowing European economies and falling inflation help build a case for an ECB rate cut, but I don’t see the ECB cutting rates anytime in the first half of the year. Remember, the economic slowdown is the natural reaction the ECB was looking for to slow inflation.
Now that it’s happening, the bank won’t leave the battlefield until it’s sure that inflation shows no signs of life. But the EURUSD is understandably extending its losses within the bearish consolidation zone as the German 10-year yield falls below the 2.20% level. The EURUSD is now testing the 100 DMA to the downside. Trend and Momentum indicators are comfortably bearish, and the RSI indicates that the market is not yet oversold. As such, the sell-off may deepen towards the 1.07/1.730 region.
Of course, the direction of the EURUSD will also depend on what the USD leg of the pair does. We see the Dollar Index rebounding this week, despite falling yields, driven lower by a soft set of US employment data released so far this week.
The JOLTS data showed a significant drop in job openings in October, while yesterday’s ADP print showed around 100,000 private sector jobs added last month, much less than the 130,000 analysts had penciled in. There is no obvious correlation between this data and Friday’s official NFP reading, but the fact that independent data points to further easing in the US labor market comforts Fed doves in the idea that, yes, the US labor market is finally giving in. On the yield front, the US 2-year yield is holding steady in the 4.60%/4.65% range, while the 10-year yield fell to 4.10% yesterday, down from over 5% at the end of October.
This is a big, big drop and it means that investors are now increasing their bets on a US slowdown. That’s why we don’t see US stocks reacting to the further drop in yields. The S&P500 and the Nasdaq both fell yesterday, while their European counterparts extended their gains despite the overbought conditions. The Stoxx 600 closed above 470 yesterday. Softening ECB expectations are certainly the main driver of European equities towards ytd highs; German equities hit an ATH yesterday despite the undoubtedly gloomy economic outlook. Current levels scream correction.
