Crude oil futures have been on a bit of a tear for the last week or so, posting only one down day in the last six days of trading, and gaining over six percent in the process. That has largely been about two things. The approach of Hurricane Idalia has been raising fears about disruptions in supply, and there was a drop in inventories here in the States last week that signals that there is already a slight imbalance in supply and demand, even before the storm’s impact. That is a bullish scenario, for sure, but it is very US-centric, and may be short-lived even there. Obviously, any impact from Idalia will be temporary, but the bullish influence of the US economy could well fade soon, too.
Yes, other international benchmark futures have also gained ground, but not by as much as WTI, the main US contract. Brent, for example, has risen less than five percent during the same period. There is nothing striking or unusual about that, the Brent WTI spread moves all the time, but it suggests that more than 25% of the gains in WTI are down to domestic influences, and those influences are far from long-term. In fact, based on data released on Wednesday morning, the outlook for US growth, and therefore US crude oil consumption is not at all encouraging.
The Importance of Core PCE
The important part of Wednesday morning’s report was what is known as core PCE, personal consumption expenditure after food and energy are stripped out. You might ask why that data…
Crude oil futures have been on a bit of a tear for the last week or so, posting only one down day in the last six days of trading, and gaining over six percent in the process. That has largely been about two things. The approach of Hurricane Idalia has been raising fears about disruptions in supply, and there was a drop in inventories here in the States last week that signals that there is already a slight imbalance in supply and demand, even before the storm’s impact. That is a bullish scenario, for sure, but it is very US-centric, and may be short-lived even there. Obviously, any impact from Idalia will be temporary, but the bullish influence of the US economy could well fade soon, too.
Yes, other international benchmark futures have also gained ground, but not by as much as WTI, the main US contract. Brent, for example, has risen less than five percent during the same period. There is nothing striking or unusual about that, the Brent WTI spread moves all the time, but it suggests that more than 25% of the gains in WTI are down to domestic influences, and those influences are far from long-term. In fact, based on data released on Wednesday morning, the outlook for US growth, and therefore US crude oil consumption is not at all encouraging.
The Importance of Core PCE
The important part of Wednesday morning’s report was what is known as core PCE, personal consumption expenditure after food and energy are stripped out. You might ask why that data point, which was once considered a somewhat obscure, specialized version of inflation numbers, is important. The answer to that question is that core PCE is important because Jay Powell says it is. The Fed Chair has stated that it is this Fed’s preferred inflation indicator, making it the most influential number released each month these days.
And the news this morning was not good.
Impact on The US Economy
Okay, technically it was pretty neutral. Core PCE rose by a 4.2% annual rate, which was what economists were expecting. However, both US stocks and WTI have been showing strength for a couple of months based on expectations that the Fed is done with rate hikes, and these data made that a much less likely scenario on Wednesday than it was on Tuesday.
The Fed’s target rate for inflation is a core PCE rate of 2%. The July print of 4.2% is more than double that target rate, and nor are the numbers moving in the right direction. The July print is, in fact, a tick higher than for the previous month. How can Powell, having said on multiple occasions that his decisions will be driven by the data, not raise rates next month when his stated preferred indicator is looking worse now than last month? I know one month’s numbers are not necessarily a good guide, but a Fed Chair is always very conscious of the optics of any decision, and particularly on that decision’s impact on how trustworthy traders, investors and bankers deem him to be. For Powell to now get all dovish, when inflation is at best steady at double his target, would erode a lot of trust in what he says in the future. He cannot afford that to happen.
Can Consumers Continue to Drive Growth?
So, with another rate hike next month now looking more likely than another pause, economic growth in the US is about how long consumers can ignore rising rates. They have done that so far but have done so largely by increasing their debt levels, as I pointed out a couple of weeks ago in an article for Nasdaq.com. That is not a sustainable path and, should rates keep rising, the reckoning on that accumulation of consumer debt could arrive soon and be quite painful when it does. And that is not even considering the impact of higher rates on US government debt of close to $33 trillion!
The Impact on WTI Futures
Markets, though, including WTI futures, have been working for a couple of months on the assumption that the Fed is pretty much done with rate hikes. Something has to give and a reversal in crude over the next week or two therefore looks likely.
How I Will Be Trading It
That doesn’t mean that I will be selling a bunch of long-dated futures and waiting in hope of a big drop, but it does mean that I will be trading with a short bias for a while. Lest you have not heard me explain that before, it means that I will be running looser stops on short positions than long, and, when target levels are hit on shorts, I will be more inclined to take only a partial profit and convert the remainder to a long-term position with a stop loss level making that, at worst, a breakeven trade. That approach allows me to still make money should I be wrong about the next few weeks or months, but to be positioned for the drop that I am expecting.
