January crude oil finished sharply higher last week. The rally was primarily driven by greater demand for risky assets fueled by a weaker Dollar and stronger equity markets. The market started out weak, but at mid-week the U.S. Federal Reserve and other major central banks joined in a coordinated effort to flood the financial markets with Dollars.
The added liquidity wasnât the only factor driving the crude oil market higher. Increased tensions in the Middle East caught the interest of traders as events continue to draw the global community closer to implementing economic sanctions against Iran. Some traders are also discussing the possibility of war especially since Iranian students took violent action against the British embassy.
An improving U.S. economy played a small role in helping to boost oil prices although the bigger story was the added liquidity.Â The U.S. Non-Farm Payroll employment report showed an increase in jobs and a decrease in the unemployment rate. This report showed that the economy was continuing to hold its own despite the woeful state of the European debt markets.
The shot in the arm that the financial markets received is just a short-term fix. Major problems still exist in Europe which some claim is the reason for the release of Dollars into the free-market. With the European Central Bank unable to prevent the rise in borrowing rates in Spain and Italy and the threat of a rumored bank collapse in France, the central banks had to make a pre-emptive strike to prevent a credit market shutdown like the one that occurred in 2008.
Another thing that the new liquidity buys is time for the European leadership to get their financial houses in order. Talks begin this week that could spark serious talk of a long-term solution to the European debt crisis. This could give the Euro a boost. However, if the summit becomes a âmeeting to schedule another meetingâ like the recent discussions then traders are likely to pressure the Euro and higher risk commodities with a vengeance. This could put short-term pressure on crude oil.
This week, traders should look for the news in the Middle East to create a floor in the crude oil market. The strength of the market will be determined by how the events unfold. If conditions continue to worsen through the implementation of military action then look for oil prices to soar. General protests and rhetoric is likely to keep a firm tone in the market, but not likely to drive prices higher.
Solid U.S. economic news could also underpin the crude oil market as well as progress during the European summit. News that the sovereign debt crisis is spreading or Franceâs debt rating has been lowered will have a negative affect on the Euro. This could limit crude oil gains but are not likely to turn the market lower. With the short-term focus on possible military action, it is going to take a financial disaster to break this market.
Factors Affecting Crude Oil This Week:
Supply and Demand:Â An improving U.S. economy continues to increase demand and lower supply. This has been underpinning the market.
European Sovereign Debt:Â Traders are still focused on the debt problems of Italy and Spain. News that France may have its debt rating downgraded has also cast a negative pall on the market. Last weekâs bailout by the central banks was a show of power but also a sign that they will not tolerate a credit market shutdown. Traders will be looking for something positive to come out of the European Union summit.
U.S. Economy:Â Talk of a recession has disappeared. The jobs picture is improving and the Dollar fell last week, increasing the chases of greater demand for U.S. goods. The lack of progress in Europe continues to stand in the way of a strong recovery in the U.S. economy.
Middle East Conflicts:Â The instability in the Middle East is making traders nervous. Traders appear to be pricing in a conflict which could lead to a shutdown in exports from the region. This will drive prices up sharply. Itâs unlikely that peace will break out next week so expect the threat of sanctions to continue to underpin crude oil prices.
By. FX Empire
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