Higher oil prices could trigger inflation fears again, undoing part of the central banks’ efforts of the past year to tame soaring consumer prices.
The fundamentals picture of the oil market looks much more bullish than just a month ago, as demand remains resilient despite concerns of slowing economies, while supply is shrinking thanks to the cuts from OPEC+ and Saudi Arabia.
But higher oil prices, which lead to higher gasoline and overall energy prices, could start seeping into core inflation again, even if the headline index excludes food and energy prices. If higher energy prices impact the inflation core again, the ‘soft landing’ hopes could begin to fade and prompt the Fed and other central banks to continue with the interest rate hikes, unlike most current expectations that the end of the rate-hike cycles is near.
And the higher oil prices of recent weeks, with Brent above $87 per barrel early on Thursday, could be the best cure to high oil prices.
In a deteriorating economic environment, oil demand growth and consumer confidence and consumption would be lower, dragging oil prices down.
Bullish Fundamentals
Fundamentals currently look strong.
Oil market participants seem to have shaken off the doom-and-gloom sentiment, or as Goldman Sachs analysts wrote in a note at the end of July, “The market has abandoned its growth pessimism.”
“Our economists note that positive surprises on growth and inflation are spurring soft-landing hopes, and we continue to see commodities as an under-loved asset class,” JPMorgan analysts wrote in a recent note carried by Bloomberg. Related: Oil Ticks Higher On Fuel Inventory Draws
Demand is not only resilient but headed for a record high in the coming months, according to analysts including Goldman Sachs and oil executives, including ExxonMobil’s CEO Darren Woods.
The world will see a record-high demand for oil this year, Exxon’s top executive told CNBC at the end of last month.
Global oil demand reached a record high of 102.8 million bpd in July, Goldman Sachs analysts wrote in a recent note. The Wall Street bank expects the robust demand to lead to a wider-than-expected market deficit of as much as 1.8 million bpd in the second half of 2023 and to 600,000 bpd deficit in 2024.
Demand looks stronger than many had expected early in the second quarter.
Oil demand outside China is holding up “far better” than most have feared, while the very aggressive OPEC+ cuts are leading to a deficit on the market, Jeffrey Currie, Goldman Sachs’s global head of commodities research, has told CNBC.
On the supply side, banks and analysts expect large deficits this quarter as supply is shrinking, courtesy of the OPEC+ production and export cuts, while demand is robust despite fears of recessions and an underwhelming Chinese economic performance.
Saudi Arabia has just extended its unilateral 1 million barrels per day (bpd) cut into September, and Russia has promised another cut to exports by 300,000 bpd in September after a 500,000 bpd reduction in August.
Market speculators have rushed to cover shorts on oil futures after the Saudis extended a one-month cut into a three-month cut and signaled the output reduction could be further extended or even deepened and extended.
“The fact the bulk of recent aggressive fund buying in response to a +17% rally has been driven by short covering instead of fresh longs, show a current hesitancy about getting too extended,” Ole Hansen, Head of Commodity Strategy at Saxo Bank, wrote in an analysis on Wednesday.
“It highlights the risk when a rally is being driven by a political and economic motivated production cut, and not a sustained rise in demand driven increased economic activity,” Hansen added.
“With that in mind, we maintain our $80 to $90 price range forecast for the current quarter, unless the economic outlook counter to our expectations show signs of improving,” the strategist added.
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Bearish Macro?
Still, if oil prices continue to rise, demand from major importers could falter compared to previous months. The specter of energy-driven accelerating inflation is looming. Oil and food prices have risen in recent weeks, and even if they are not part of the core inflation readings, they stoke the prices of everything while wage growth continues in some major economies—a recipe for accelerating inflation.
“It would be foolish for any central bank to declare victory,” Randall Kroszner, a former governor of the US Federal Reserve System and now an economics professor at the University of Chicago Booth School of Business, told CNN this week.
The previous U.S. inflation reading for June was bullish for hopes of a “soft landing”, but the market would need further proof that the decline is sustainable.
Meanwhile, U.S. gasoline prices are rising and higher energy prices could delay the end of the current cycle of interest rate hikes, intensifying fears of recessions.
By Tsvetana Paraskova for Oilprice.com
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