Crude oil prices have gained roughly 10 percent since hitting a low point in late December, and there are plenty of signs that suggest the market is poised to claw back some further gains in the months ahead. However, all of that depends on the health of the global economy, which is not necessarily guaranteed to cooperate.
In fact, a slew of evidence is mounting that global economic activity is starting to slow. U.S. manufacturing data from December points to a slowdown. The Institute for Supply Management’s purchasing managers’ index declined by 5.2 points last month, the largest monthly decrease in ten years.
China recently posted similar numbers. Manufacturing activity in China contracted in December, the first time it has done so in nearly two years. “That showed external demand remained subdued due to the trade frictions between China and the U.S., while domestic demand weakened more notably,” wrote Zhengsheng Zhong, director of macroeconomic analysis at CEBM Group, a subsidiary of Caixin. “It is looking increasingly likely that the Chinese economy may come under greater downward pressure.”
Apple this week slashed its revenue outlook for the first time in nearly two decades, and its share price plunged by 10 percent in response. The lower revenue projection largely comes down to disappointing sales in China. Apple’s fortunes may seem irrelevant to the oil market, but to the extent that it is a symptom of a slowdown in China, then oil traders should probably pay attention.
The good news is that the U.S.-China trade war has recently shown some signs of a thaw. Presidents Trump and Xi apparently made good progress on trade disputes during a phone conversation a few days ago. If they can hash out a deal that heads off steep tariff hikes, it could cushion the blow of a potential economic slowdown. The temporary truce between the two countries ends in March.
The problem is that economic trends, once they get going, can build on themselves, leading to compounding pain. If the economy slows, companies respond by cutting investment, hiring and spending, which slows things down even further. The same is true in bond and equity markets – falling asset prices can kick off stronger short selling. These “doom loops,” as Satyajit Das of Bloomberg Opinion calls them, represent serious pitfalls for the global economy 2019.
The Federal Reserve reportedly places the odds of an economic recession this year at 16 percent, which is the highest reading since 2008. The Fed itself is helping to play a role in boosting those odds, hiking interest rates in the face of a darkening economic outlook. The central bank raised interest rates in December and is expected to do so two more times this year.
An obscure but important metric suggests an economic recession could be forthcoming. Last month, the yields on five-year U.S. Treasury notes fell below those of two- and three-year notes. Such a development has reliably preceded economic recessions in the past.
What does all of this mean for oil prices? The market is oversupplied, although prices have already fallen quite a bit to reflect that reality. It’s conceivable that the worst is over, with OPEC+ phasing in supply cuts and Iran sanctions waivers set to expire in several months.
But the demand picture is completely up in the air, which is ironic because demand has been steady for several years while supply has confounded analysts. To be sure, predicting supply growth this year is also problematic, but for the first time in quite a while, there is quite a bit of uncertainty about the health of oil demand.
The uncertainty is having near-daily effects on oil prices. “Oil is flip-flopping on concerns of supply and demand,” Phil Flynn, an analyst at Price Futures Group in Chicago, told Reuters. “It's really a battle between the supply situation, which looks to be tightening, versus the possibility that demand will drop off.”
By Nick Cunningham of Oilprice.com
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