In a move that has been anticipated for several weeks, Nearby crude oil futures plunged sharply lower the week-ending February 22 after support for higher-risks assets fell across the board following comments in the Fed’s latest minutes. The sharp break did not catch chart-watchers by surprise since the recent patterns on the daily and weekly charts had indicated the formation of resistance and the possibility of a change in trend to down over the near-term.
With a distributive pattern taking place near a downtrending angle, traders were waiting for a catalyst to trigger long liquidation. It seems that sellers and short-traders were willing to play the waiting game until some news event forced their collective hands. According to the latest U.S. government Commitment of Traders report dated February 20, for the second straight reporting period long speculators increased positions while commercial traders added to their short positions. This essentially turned into the classic battle between smart money and trend-followers.
The smart money or commercial traders looked at the economic situation and determined that they were comfortable with shorting at the lofty price levels as the market approached $100.00. Trend traders, on the other hand, were driven by headlines of an improving economy and the unending Fed stimulus. Although the recent action suggests that trend traders most likely bailed out at the right time when the trend changed to down, those who went long over the past month took hard hits, thereby increasing the amount of volatility to the downside. These traders were basically scrambling to get out the door, but there was only one exit. This explains the size of the drop we saw on February 20 when crude oil fell from $97.49 to $94.21.
Technically speaking, based on the range of the rally of $85.95 to $98.79, expectations are for Nearby crude oil to test a retracement zone at $92.37 to $90.85. This may become support, but it is more likely that prices will stay here until the fundamental traders can reassess the economic conditions.
Reassessment of the economy is necessary at this time because of what was said in the Fed minutes. Since 2008 the U.S. Federal Reserve has been providing stimulus to the economy. This has led to a historically low interest rate environment. Additionally, investors have had no alternative but to put money into higher yielding assets such as equities, commodities and currencies. This has also hurt the price of the U.S. Dollar, and since crude oil is priced in dollars, it rallied as the dollar weakened.
On February 20 the Fed minutes stated that several Federal Open Market Committee members had considered shutting down its bond-purchasing program sooner-than-expected. This shocked the financial markets because they had been operating under the notion that the Fed buying was indefinite. Now that it appears there may be an end date, uncertainty as to when the Fed will shut down the program is causing worry and concern.
With the prospect of rising interest rates looming, some money managers believe that a premature hike in interest rates would hurt the economy since it is still on shaky ground. This is leading to the thought that demand for crude oil may fall while the economy tries to regain traction. Essentially what it boils down to at least in the short-run is that the thought of higher interest rates is likely to mean less demand for crude oil and that can’t be good for price appreciation.