Last week we saw OPEC+ come to terms on a deal to extend their existing supply cut agreement into March of 2020. With that transaction in the rearview, we think oil markets will likely spend much of July being macro-obsessed with a high degree of interest in the US Fed’s next interest rate decision on July 31st with guidance coming from US Fed Chief Jerome Powell in public remarks today and Thursday. There will doubtless be attention paid to US/China trade relations, Iran’s recent uranium enrichment efforts and global crude fundamentals but the Fed’s next move could be of intense interest as global growth concerns likely reclaim center stage.
Major central bank moves are always of interest to risk assets but we think the current one is setting up to particularly impactful for two reasons. Firstly, there seems a slight disconnect to us on what markets are expecting for Fed actions versus the messaging we’re getting from the central bank’s leadership. Second, OPEC+ is unlikely to make headlines anytime in July, clearing a path for focus on the state of the global economy to retake traders’ focus. US refiner demand is currently lower y/y by about 300k bpd despite solid GDP growth and we are increasingly concerned about the ability of this market to generate demand growth in the second half of the year.
On the first point, recent volatility in short term Treasuries suggests traders have a diverse set of views on what the Fed might do in late July and for the balance of 2019. The yield on the US 2yr bond dropped from 1.94% to 1.69% in June as odds of lower rates increased, but recent hawkish comments from Fed officials have led a rally back to 1.91%. Fed Fund Futures on the CME, however, are trading at levels which imply 94% odds of 25 basis point rate cut on the 31st and a 6% chance of a 50 basis point cut. We think these two trends reveal a disconnect within bond markets as Treasuries seem uncertain on the Fed’s next step while Fed Fund Futures are awesomely confident in a dovish move. We also think that pricing in 100% odds of a Fed rate cut following the US June employment number +224k jobs is somewhat absurd and creates potential for volatility.
On the second front, flattening in stock markets related to weak earnings projections and central bank concerns has refocused us on the idea that global economies are sick and in need of help from policy makers. This week strategists at Morgan Stanley flipped to ‘underweight’ on US equities due to earnings downgrades and global trade headwinds. We’re also seeing evidence of a weak macro background almost every week in Department of Energy data where the US is suffering from y/y declines in refiner demand and domestic gasoline demand + exports despite GDP growth comfortably in excess of 2%. Significant unplanned supply outages persist from Iran to Venezuela and OPEC has maintained strict discipline in planned supply cuts yet Brent can’t sustain a run over $70. Isn’t that a curious set of circumstances? What else could we point to here except for chronically poor demand and an oil market which is possibly trying to give us an early warning sign that the global economy is even weaker than we think?
Looking ahead, we’ll be focused on fixed income and currency markets for hints on what the Fed might do later this month and how central bank actions could spill into oil markets. Unlike Fed Fund Futures, we’re far from certain on what policy makers will do in July, but we have a hunch the bearish macro picture will be back in focus in the coming weeks.
- Brent crude oil moved sideways near $64 this week with bullish pressure coming from the recent OPEC+ deal and provocation from Iran while a jittery macro background kept a lid on rallies.
- Iran’s military publicly said they will retaliate in response to the seizure of an oil tanker by the British Marines last week which held Iranian crude. Traders seem to be taking the threat seriously as a BP oil tanker turned away from Iraq’s Basrah terminal and moved towards Saudi Arabia on July 6th on fears the vessel could have been attacked. Meanwhile Iran’s political leaders have stated they will continue to enrich uranium above levels which violate the JCPOA as long as they are barred from global markets.
- Geopolitical issues are piling up from Caracas to Tehran but fundamentals-focused traders seem unconcerned. This week the month 1 v. month 2 brent spread traded just 23 cents contango which implies modest global inventory draws in the coming weeks at a time when crude oil and gasoline stocks should be in rapid seasonal decline. The same time period spread for WTI is just 6 cents contango as strong US production and weak US demand are pushing more barrels into the Cushing, OK delivery hub.
- US equity markets took a hit at the end of last week when a better than expected June employment number (+224k jobs) injected fear into markets that the US Fed may not be as dovish as hoped. The S&P 500 traded near 2,980 this week representing a 19% climb YTD.
- US Fed Chair Jerome Powell is set to appear in front of congress this week with traders glued to the TV for signals on what the central bank’s next move might be. Markets currently expect a 25 basis point rate cut to come at the end of the month, so anything other than a reassuring, dovish tone from Powell could be highly bearish across risk assets.
- As we mentioned in our opening piece, the US 2yr yield recently spiked above 1.9% following semi-hawkish comments from two members of US Fed leadership.
- The US Dollar index has also spiked higher moving from 96.0 on June 25th to 97.5 this week. Like the move higher in yields, this seems to conflict with the certainty seen by Fed Fund Futures that the US central bank is going to cut rates at the end of the month.
DOE Wrap Up
• US crude stocks fell by 1.1m bbls last week despite a decrease in demand, an increase in production and a sharp jump in net imports.
• Crude inventories in the Cushing, OK delivery hub increased by 650k bbls to 52.5m.
• Domestic crude production had a slight uptick last moving to 12.2m bpd. US producers have averaged 12.1m bpd of output so far in 2019 up from 10.8m bpd in 2018 and 9.4m bpd in 2017.
• As for trade, the US imported 7.6m bpd last week up from 6.7m bpd the week prior. US traders also imported 4.6m bpd last week up from 2.9m bpd in previous week.
• US refiners processed 17.3m bpd last week moving down w/w by about 40k bpd. US demand has averaged 17.24m bpd over the last four weeks which is lower y/y by about 430k bpd. Refiners have averaged 16.5m bpd so far in 2019 which is lower y/y by about 280k bpd.
• The US currently has 27.2 days of crude oil supply on hand moving slightly lower from its 28.0 average over the last four weeks. The 28.0 average is higher by about 15% y/y.
• Gasoline inventories fell by 1.6m bbls w/w to 230.6m and are lower y/y by about 3% over the last four weeks.
• US distillate stocks jumped by 1.4m bbls last week to 127m and are higher y/y by 9% over the last four weeks.
• US gasoline demand + exports printed 10.05m bpd last week for a w/w drop of more than 300k bpd. Implied US gasoline demand averaged 10.36m bpd in June which was lower y/y by about 75k bpd. Implied demand has averaged 9.97m bpd so far in 2019 which is lower y/y by about 50k bpd.