FlowBank

Crude Oil Starts Q4 Well - Is the Bottom in?

Volatility is one of the main reasons traders are drawn to trading oil. ‘Black gold’, as it is often referred to in trading circles, is notorious for outsized price swings when compared with more typically stable assets such as equities. 

This volatility is a double-edged sword and erratic price movements can often catch newer traders off-guard. Over the last 4 months, oil prices have been in a fairly steady downtrend since the reversal from Q2 highs. However, looking at price action more recently we can see that crude futures have enjoyed a sizeable +20% rally off the lows of Q3.

 

Many traders are now questioning whether this is merely another correction and positioning clear-out before we see a fresh leg lower or whether this is the start of a fuller recovery aimed at taking oil back up through $100 p/b. 

In order to gain a view on this, let’s take a look at the factors impacting oil prices currently and how they look set to influence prices over the remainder of the year. 

Factors Impacting Oil Prices

  • USD Volatility 
  • Fresh OPEC+ Supply Cuts
  • China COVID Concerns

USD Volatility 

The rebound in oil prices over recent weeks has been fuelled in part by the correction in the USD. With the idea of a potential ‘Fed pivot’ gaining traction again recently, USD was seen pulling back from 20-year highs. This correction saw a widespread rally in risk assets, lifting commodities prices and benefiting oil greatly. 

And more than being just a ‘risk-on’ market phenomenon, the effect of stable rather than rising interest rates would likely be inflationary and support commodity prices.

Fresh OPEC+ Supply Cuts

Oil prices have also been helped higher by the recent announcement by OPEC+ that it will cut supply levels by 2 million barrels per day. The group cited the need to lift ailing oil prices as the driver behind the move. These cuts mark the largest such adjustment since COVID began in Q1 2020. The impact of the cuts is already being felt with reports this week that European petrol prices are rising again for the first time in three months. 

China COVID Concerns

Despite the recent rally, however, and some of the factors currently supporting oil prices, there are plenty of downside risks to note. Among these, the economic outlook in China is a key factor. Oil prices were heavily impacted by the economic repercussions of the Chinese lockdowns put in place across Q1 and Q2. With Chinese economic activity suffering greatly, oil demand cratered, sending oil prices lower. 

While the Chinese economy has been recovering following the broad easing of restrictions in recent months, there are renewed concerns about the potential for a return to lockdowns in the coming months. A fresh spike in COVID cases, particularly in Shanghai which was one of the regions locked down earlier this year, is raising concerns that lockdowns will return. If this does happen, we can expect oil prices to come off once again as the demand outlook worsens. 

What to monitor for oil going forward

  • Global Economic Outlook 
  • USD Movements & Fed Actions

Global Economic Outlook 

The broader global economic outlook is also a key factor in gauging the likely direction of oil prices in coming months. Rising fears over a global recession have been weighing heavily on oil prices in recent months, hence the need for OPEC+ to reduce supply. With central banks around the globe continuing to tighten monetary policy and with inflation still at excessive levels, a further slowing of global economic activity looks likely by the end of the year. 

These risks are heightened further by the energy crisis which looks set to take a heavy toll on households and businesses in the West this winter.  Consequently, the demand for oil is likely to weaken. If demand does fall materially, it will be prudent to monitor OPEC+ for any further supply cuts in the coming months which might help counter any oil price decline. 

USD Movements & Fed Actions

Finally, the path of the US Dollar is a major factor to monitor over the coming months. With inflation still at an elevated level, the Fed looks set to continue pushing ahead with further rate increases which should keep USD supported near-term. 

Fed commentary has been consistently hawkish recently leading market pricing to favour a larger 75bps hike again in November. Additionally, recent Fed comments around the need to keep restrictive monetary policy in place for longer, to ensure inflation returns to target sustainably, means that rates are likely to sit at higher levels for longer next year, again fuelling prolonged support for USD which should keep oil prices pressured lower. 

However, given the rally already seen in USD over the last year, if this narrative shifts at all, USD is vulnerable to a sudden positioning-based move lower, which could send oil prices quickly higher. 

Technical View

WTI Crude Weekly Chart 

Source: FlowBank / Trading View

 

WTI Crude oil prices recently tested the bear channel resistance level which has held once again, for now. Currently, the market is sitting on support at the 86.0 level which, if held, could market the start of a bullish reversal through the 94.0 level towards 100/101. To the downside, should the price break below 86.0, a rotation towards the channel lows around 76.20 and current YTD lows looks likely. 

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