Oil jumped on OPEC optimism about rebalancing; Nasdaq slid

Oil (WTI-Sep Exp) jumped around +1.83% to close around 88.89 Tuesday after OPEC’s latest report indicated faster rebalancing/tightening. OPEC's continued projection of strong oil demand growth. According to the Organization of the Petroleum Exporting Countries (OPEC), global oil demand is expected to increase by 2.25 mbpd in 2024, slightly lower than the 2.44 mbpd growth projected for 2023.

OPEC+ initiated supply limits in 2022 to stabilize the oil market and recently, Saudi Arabia and Russia decided to extend their voluntary production cuts until the end of the year. However, new data showed that OPEC oil production increased in August, primarily due to Iran's production recovery, despite the ongoing US sanctions on Tehran and Saudi Arabia's voluntary cuts.

On Tuesday, OPEC’s latest MOMR (Monthly Oil Market Report) for September noted:

·         Oil output rose by 113,000 bpd to 27.45 mln bpd in August led by an increase from Iran and Nigeria

·         OPEC leaves 2023 world oil demand growth forecast unchanged at 2.44 mbpd

·         OPEC leaves the 2024 world oil demand growth forecast unchanged at 2.25 mbpd

·         OPEC maintains its view that pre-Covid-19 levels of total global oil demand will be surpassed in 2023

·         OPEC raises 2023 non-OPEC supply-growth forecast by 100,000 bpd to 1.6 mbpd

·         OPEC keeps the 2024 non-OPEC supply-growth forecast steady at 1.4 mbpd

·         OPEC maintains a 2023 global economic growth forecast at 2.7%

·         OPEC crude output rose by 113,000 bpd in August to 27.45 mbpd

·         OPEC, citing secondary sources: Saudi Arabia's crude output fell by 88,000 bpd in August to 8.97 mbpd

·         OPEC keeps 2024 global oil-demand growth forecast at 2.2 min bpd

·         OPEC keeps the 2023 global oil-demand growth forecast steady at 2.4 mbpd

·         OPEC keeps the 2024 global economic growth forecast unchanged at 2.6%

·         OPEC data show 3 mln-barrel shortfall as Saudis extend cuts

Full text of OPEC’s comments: A review of world economic developments

“The global economic growth dynamics in 1H23 have been resilient despite the numerous challenges, including high inflation, elevated interest rates, and geopolitical tensions. This steady global economic growth trend continued into 3Q23, supported by buoyant consumer spending, especially in the services sector. With this, the global growth is expected at 2.7% for 2023 and 2.6% for 2024.

The downside risks for this projection include the elevated key interest rates in G7 except Japan, challenges in China’s growth dynamic, and a continuation of the conflict in Eastern Europe. Sovereign debt levels have reached record highs in many economies, and are also a rising concern. However, an upside potential may come from less accentuated inflation, providing central banks with room for accommodative monetary policies in the near term.

Emerging Asia, particularly India, Brazil, and Russia, could further surprise the upside, with domestic demand and external trade accelerating. An even stronger-than-anticipated growth trend in China, supported by further fiscal and monetary stimulus, may provide additional support to global economic growth. Moreover, if the US continues to keep its current momentum, growth could turn out to be higher than expected.

Most of the support for global economic growth this year came from the ongoing rebound in the services sector. In particular, the contact-intensive areas of the services sector, including leisure, travel and tourism, experienced an extended boom after the long period of pandemic-related lockdowns. As China and Japan withdrew their COVID-19-related restrictions only at the start of this year, positive economic activity has been especially strong in East Asia.

Going forward, an important dynamic in shaping the trajectory of the global economy will be the balance between the sectorial contributions of the industrial and services sectors. Economies that are skewed towards the industrial sector, which were more successful during the pandemic years, are currently lagging in terms of growth dynamics. The current large weight of the services sector contribution is forecast to gradually taper off while the industrial input to the global economy is expected to gain momentum towards the end of the year.

The ongoing global economic growth is forecast to drive oil demand, especially given the recovery in tourism, air travel, and steady driving mobility. Oil demand is expected to grow by 2.4 mb/d y-o-y in 2023 and 2.2 mb/d in 2024. Pre-COVID-19 levels of total global oil demand will be surpassed in 2023 to average at 102.1 mb/d and rise further to 104.3 mb/d in 2024.

On the supply side, OPEC and non-OPEC countries participating in the Declaration of Cooperation (DoC) continue to assess the market conditions, address its challenges, and take necessary measures at any time and as needed to ensure market stability for the benefit of producers, consumers and the global economy.”

Market wrap:

On early European Tuesday, Wall Street Futures stumbled after a subdued report card of Oracle and a survey report by economists indicated higher for longer Fed policy; Fed may not talk about rate cuts until at least March ’24. The market was also concerned about elevated & sticky core service inflation reading Wednesday, paving the way for a hawkish hold stance by the Fed on 20th September, followed by another +25 bps hike on 1st November. Subsequently, USD/US bond yield surged, and Gold, and Wall Street Futures stumbled. Oil surged on the OPEC report (jawboning), but slipped later after the API report showed unexpected inventory buildup.

On Tuesday, the blue-chip Dow Future stumbled -0.50%, broader SPX-500 lost -0.55%, while tech-heavy NQ-100 Future tumbled over -1.00%, dragged by Microsoft, Apple and Oracle. Apple announced at its annual event that the iPhone 15 with USB-C charging starts at $799 and unveiled the brand-new Apple Watch-overall subdued promotion event for Apple.

On Tuesday, Wall Street was boosted by energy (higher oil), financials, and utilities to some extent, while dragged by techs, communication services, consumer discretionary, consumer staples, industrials, materials, healthcare and real estate to some extent.

Conclusion:

The U.S. economy is slowing down, but core service inflation is still quite elevated and sticky; the Fed may hike in November even after a pause in September.

Overall, the YTD (2023) average of underlying core CPI inflation is now around +5.3% and core PCE inflation +4.5%; overall average core inflation (CPI+PCE) is around +4.9% (~5.0%) against the Fed’s current repo rate of +5.50%; i.e., the real repo rate (wrt core inflation) is now around +0.5% (real positive) and at the mid-zone of Fed’s restrictive rate zone (5.00-6.00%).

Although the Fed officially targets core PCE inflation, Fed Chair Powell makes it quite clear that the Fed is now also targeting core CPI inflation to bring it down to +2.0% targets. Also, core service inflation is still quite elevated and sticky, although goods inflation has turned almost negative (deflation). The divergence between core PCE and core CPI inflation continues to be around +1.0% due to differences in constituents and weightage.

In this way, the Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for July-September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a pause in Dec’23.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation (CPI+PCE) =5.50% (for 2022); now average core inflation (CPI+PCE) is around +5.0% for 2023 (YTD); 6M average core inflation (2023) around +4.95%

Fed may go for a pause on 20th September but may hike another +25 bps on 2nd November, if core inflation does not fall significantly. Fed may go for a long pause to assess the underlying core inflation trend and outlook along with the labor market for July-Sep’23 economic data. Fed may project at least another hike in 2023 in its September dot-plots (SEP) depending upon the actual economic data and outlook. If there is no significant easing of core inflation, especially core service inflation, then the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle.

Fed may now go for a long pause, at least till 1st November’23, to assess the underlying core inflation trend and outlook along with the labor market for July-September ’23 economic data. If core CPI inflation indeed eased further to around +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).

At the current run rate/trend, core CPI inflation should be around +4.0% by Dec’23, +3.0% by June’24, and +2.0% by Dec’24; i.e. at target ahead of the Fed’s estimate of Dec’25. But looking at the overall trend, higher oil prices, and core CPI inflation may also spike again in August-September.

Also, oil prices may stay elevated in the coming months between $75-85 instead of the earlier $65-75 despite US efforts to bring more supply from Iran, and Venezuela (by lessening sanctions) as OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $80 will continue to boost energy/transportation costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $80 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.

The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.

In any way, if average U.S. core CPI inflation indeed falls below +4.0% by June’24 (H1CY24) on a sustainable basis, the Fed may go for a +25 bps cut each in July’24 (just ahead of the Nov’24 US Presidential Election) and thereafter every alternate meeting to keep the real repo rate around +1.0% (from 3M/6M average core inflation).

Looking ahead, from March ’24, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price stability and soft-landing. Overall, it seems that the White House would be quite happy if the Fed could bring back core inflation towards 2% on a durable basis, while keeping the unemployment rate below 4% ahead of Nov’24, the U.S. Presidential election.

Bottom line: Technical trading levels: Oil

Technically, whatever may be the narrative, oil now has to sustain over the 90.25 area for the next leg of rally towards 93.00/95.00-102.00/115.00-120; otherwise sustaining below 90.00-85.00, it may correct again towards 75.00 area in the coming days.