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Forget The Middle East – This Is The Real Threat To Oil


Oil prices continued to fall this week as the US and China stoked concerns that the two sides will fail to cooperate on a trade deal anytime soon. On the US side, officials moved forward with plans to limit capital flows into Chinese markets and continued efforts to blacklist certain Chinese businesses. On the Chinese side, leadership used media outlets to suggest that a trade deal was unlikely anytime soon and that the coming meeting this Thursday between US and China trade officials was unlikely to accomplish much.

As macro negativity spread Brent crude sank to $58 while WTI dropped to $52.50. Both grades have lost more than $5 in the last two weeks with US/China concerns driving prices. Meanwhile, equity markets were also hit hard with the S&P 500 trading near 2,900 for a 3% loss over the last month mirroring losses in the Shanghai Composite. The US 10yr yield traded near 1.50% and the US Dollar held recent losses against the Yen and Euro following recent weakness in manufacturing and services data.

In physical markets, the news was equally bearish as a drop in the front 1-month Brent spread to +40 cents seemed to corroborate claims from Saudi Aramco that output from the Kingdom would rapidly return to full capacity following the recent production attacks. However, political unrest in Iraq- where massive protests have taken root in Baghdad- could add some bullish pressure as protests have turned violent and there are even whispers that Iran is quietly stirring the pot. Speaking of politics, Donald Trump made news this week (for once!) by announcing a plan to withdraw US troops from Syria making Kurdish forces in the region extremely vulnerable to Turkish engagement.

Looking ahead, we think markets will become increasingly focused on the US Federal Reserve meeting scheduled for October 29th-30th. Investors are currently seeing an 80% chance of a 25 basis point rate cut via Fed Fund Futures following mixed signals from central bank officials in the last few weeks. On the dovish side, Chairman Powell announced a new asset purchase program to calm recent volatility in the REPO market (although he insists this isn’t QE) and has said the central bank is on high alert for risks associated with slowing US growth and the US/China trade war. On the hawkish side, Mr. Powell and some of the regional Fed Presidents have given mostly upbeat assessments of the US economy in recent weeks.

We’re also thinking more and more about the increasingly unstable situation in the Middle East where violent Iraqi protests are now entering their second week only one month after Saudi Arabia experienced the largest unplanned oil production outage in history. As Iran, Iraq and Saudi Arabia seem to find themselves in increasingly hostile situations can the current bearish crude oil price regime continue? Now that Brent has lost more than $13 since its mid-September spike many are saying that Middle East risk is underpriced. We’re taking a different view for now, at least, thinking the recent Saudi oil attacks- and subsequent bearish price action- only served as evidence of the oil market’s inability to rally given the cloudy macro picture. In short, Washington and Beijing still pose more of a threat to oil prices than Tehran and Riyadh.

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