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A Downshift in US and Chinese Growth Marks a Critical Break for Crude

Is the global economy facing a double dip recession and a new financial crisis? That is the concern that made the capital markets swoon Thursday. A disappointing round of data for both the US and China coupled with a questionable shift in the European banking sector would have a particularly dramatic impact on crude prices for the session.

Heading into the session, the benchmark NYMEX futures contract was already pressuring a meaningful support level around $75. For technical traders, this was a notable pivot and meaningful retracement level; but even the fundamental set would recognize the psychological influence this level would have and the progress towards a meaningful reversal.

While the market may have already established its bias, momentum was drawn from very specific sources. As it has been these past few months, risk appetite was one of the primary catalysts for the slide. Taking stock of risk appetite across the market, European equities plunged while debt yields collapsed. Projecting a meaningful reversal all its own, the Dow Jones Industrial Average cleared the 9,800 level that has held up as a floor for equities for all of 2010. It was only fitting that crude – a speculative asset itself – would establish a critical development of its own.

The catalyst for the decisive shift in sentiment was a complicated matter. Over the past few months, the European Union’s financial troubles have threatened to evolve into a regional crisis that in turn infects the entire globe. Today, there were mixed signals of relief and further deterioration for the region through a debt auction and the rotation of a lending facility.

The euro took off Thursday on news that Spain’s auction of 3.5 billion euros worth of five-year note was fully bid despite Moody’s warning that the nation’s sovereign credit rating was coming under review. However, the 1.7 bid-to-cover ratio hardly reflected confidence. What’s more, a short-term three-month lending facility for European banks to tap in order to cover liabilities as the 12-month program (with 442 billion euros in outstanding loans) expired would draw another 112 billion euros. All told, this is not news to reassure; and the steep declines in European equities and certain government bonds confirm that.

The more salient and intelligible weight on price action would come via growth expectations. In the ever-changing balance between supply and demand, there remains a clear glut in energy and a remarkable shortfall in consumption. Today’s economic calendar gave reason to believe that energy use would further recede going forward with notable downgrades in the perceived economic health of the US and Chinese economies. Both reported significant declines in their respective manufacturing activity reports, which has a substantial impact on global demand given these two behemoths are the first and second largest consumers of oil in the world. Tomorrow’s data could further imbalance supply and demand. US nonfarm payrolls is considered a benchmark for the overall health of the economy. Already expected to report a net contraction on the month, it would take little to provoke continuation on a now existing trend.

Looking at the futures markets after the day’s remarkable developments, the active Nymex futures contract (August) showed a new record high for volume (approximately 383,000 contracts). Aggregate open interest is still exceptionally low, however, suggesting investors are not make the effort to secure entry at ‘depressed’ prices. Furthermore, the difference between the active US contract and the two year deferred widened to $6.31 – indicating a greater level of uncertainty through the medium to long term.

Crude Futures Chart

Written by John Kicklighter, Strategist
Questions or Comments about this article? Send them to jkicklighter@dailyfx.com




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