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Oil plunged on the concern of stagflation and the US SPR release

calendar 26/07/2022 - 20:35 UTC

Oil (WTI-Aug Exp) tumbled Tuesday after IMF downgraded global GDP growth, especially in U.S., China and India. Oil also stumbled from the session high of 98.98 and made a low of 94.83 after the White House announced another tranche of 20 MB release of the fossil fuel from the SPR by Oct’22 in addition to the already scheduled 180 MB announced earlier. So far Biden admin (U.S.) has released around 125 MB of black gold (crude oil) in the market since Nov’21.

Overall, Oil plunged almost -10% in July (till day) after over -7% plunge in June on synchronized global recession/stagflation concern despite tighter supply and Biden’s unsuccessful Middle East tour to peruse more production from Saudi Arabia and UAE. Oil made a low around 90.58 in July (till 25th), against Feb’22 low 86.55 made before the Russian invasion of Ukraine and also well of the Mar’22 high 130.50.

On Tuesday, IMF published its latest WEO (World Economic Outlook) report:

·         Latest US GDP growth prediction of +2.3% in 2022 and +1.0% in 2023, both sharply down from +3.7% and +2.3% in April estimate

·         Euro area real GDP growth would slow to 2.6% in 2022, and 1.2% in 2023 under a plausible alternative scenario of a full cut-off of Russian gas to Europe and a 30% drop in Russian oil exports

·         Until inflation is tamed, central banks should stay the course delays will exacerbate hardships

·         Under an alternative scenario, the United States and Europe would see growth falling to near zero due to increased inflation, and tighter financial conditions

·         Cuts 2023 global growth forecast to 2.9% from 3.6% in April

·         China's GDP growth forecast to 3.3% from 4.4% in April cites COVID-19 lockdowns and property sector crisis

·         IMF Chief Economist Gourinchas: Whether the United States enters a recession is determined by factors other than GDP output. It also depends on how strong the labor market is

·         The likelihood the US can avoid a recession is quite narrow

·         Fed tightening may cause the unemployment rate in the United States to begin climbing in 2023

·         Rate hikes are required for price stability

·         There is no US recession in the baseline prediction

·         Cuts Indian real GDP growth by -0.8% to +7.4% for FY22 and +6.1% for FY23, still the fastest growing major economy and higher than China

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IMF: Gloomy and More Uncertain World Economic Outlook

Tentative recovery in 2021 has been followed by increasingly gloomy developments in 2022 as risks began to materialize. Global output contracted in the second quarter of this year, owing to downturns in China and Russia, while US consumer spending undershot expectations. Several shocks have hit a world economy already weakened by the pandemic: higher-than-expected inflation worldwide––especially in the United States and major European economies––triggering tighter financial conditions; a worse-than-anticipated slowdown in China, reflecting COVID- 19 outbreaks and lockdowns; and further negative spillovers from the war in Ukraine.

The baseline forecast is for growth to slow from 6.1 percent last year to 3.2 percent in 2022, 0.4 percentage points lower than in the April 2022 World Economic Outlook. Lower growth earlier this year, reduced household purchasing power, and tighter monetary policy drove a downward revision of 1.4 percentage points in the United States. In China, further lockdowns and the deepening real estate crisis have led growth to be revised down by 1.1 percentage points, with major global spillovers. And in Europe, significant downgrades reflect spillovers from the war in Ukraine and tighter monetary policy.

Global inflation has been revised up due to food and energy prices as well as lingering supply-demand imbalances and is anticipated to reach 6.6 percent in advanced economies and 9.5 percent in emerging market and developing economies this year—upward revisions of 0.9 and 0.8 percentage points, respectively. In 2023, disinflationary monetary policy is expected to bite, with global output growing by just 2.9 percent.

The risks to the outlook are overwhelmingly tilted to the downside. The war in Ukraine could lead to a sudden stop of European gas imports from Russia; inflation could be harder to bring down than anticipated either if labor markets are tighter than expected or inflation expectations are unanchored; tighter global financial conditions could induce debt distress in emerging market and developing economies; renewed COVID-19 outbreaks and lockdowns, as well as a further escalation of the property sector crisis, might further suppress Chinese growth; and geopolitical fragmentation could impede global trade and cooperation. A plausible alternative scenario in which risks materialize, inflation rises further, and global growth declines to about 2.6 percent and 2.0 percent in 2022 and 2023, respectively, would put growth in the bottom 10 percent of outcomes since 1970.

With increasing prices continuing to squeeze living standards worldwide, taming inflation should be the priority for policymakers. Tighter monetary policy will inevitably have real economic costs, but the delay will only exacerbate them. Targeted fiscal support can help cushion the impact on the most vulnerable, but with government budgets stretched by the pandemic and the need for a disinflationary overall macroeconomic policy stance, such policies will need to be offset by increased taxes or lower government spending.

Tighter monetary conditions will also affect financial stability, requiring judicious use of macro-prudential tools and making reforms to debt resolution frameworks all the more necessary. Policies to address specific impacts on energy and food prices should focus on those most affected without distorting prices. And as the pandemic continues, vaccination rates must rise to guard against future variants. Finally, mitigating climate change continues to require urgent multilateral action to limit emissions and raise investments to hasten the green transition.

In June, OPEC+ under-produced around -2.84 mbpd than the scheduled production quota, while Libyan production was back on track a few days ago to over +1 mbpd. Also, demand from China and India eased, despite higher discounts for Russian oil. But looking ahead, Europe may also use diesel as a heating oil amid possible short/no supply of natural gas by Russia in harsh winter.

Conclusions:

Russian geopolitical tensions and subsequent economic sanctions coupled with the scarcity of real spare capacity may keep oil elevated despite the Fed-engineered U.S./global economic slowdown. USD may reverse after Fed’s much anticipated +0.75% rate hike on 27th July and commodities led by oil and gold may rally, if Powell indicates a slower pace of rate hikes in September, November and December (ahead of Nov’22 U.S. mid-term election) to avoid an all-out U.S. recession. U.S. President Biden may also request Chinese President Xi to mediate with Russian President Putin for an acceptable truce with Ukraine and a face-saving exit for Russia in return for a rollback of all G7 economic sanctions; otherwise, inflation will not come down despite continuous Fed hikes.

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