Oil heads to $100 on OPEC+ output cut? Indices flat

Talk of $100 crude oil possibilities following today's OPEC+ output cut dominated Wall Street today, with traders worried that it will bring a return of sticky inflation pressures, higher interest rates and weak financial markets.

For more detailed market commentary go to StoneX Market Intelligence, https://my.stonex.com/. 

Oil spikes on surprise OPEX+ production cuts

Crude oil prices priced above $80, and could push back towards $100 per barrel according to some analysts, following a surprise announcement by OPEC+ that its members will cut output by another 1.16 million barrels per day, threatening higher inflation, weaker economic growth or both.

Oil price manipulation with political overtones

More than half of the cut in oil production comes from Saudi Arabia, as it shows its hand in the price manipulation effort. That brings total output cuts since November to 3.66 million barrels per day, raising fears of tightness in supplies, and raising speculation that the cartel wants to see prices in the $90 to $100 per barrel range. OPEC formed an alliance with other oil-producing nations to create OPEC+, adding Russia, Kazakhstan, Azerbaijan, Mexico, and Oman, controlling over half of global oil supplies and about 90% of proven oil reserves.

Today’s move reflects a political line in the sand being drawn between OPEC+ nations including Russia, with its strong ties to China, and the US and Western nations. The cuts come amid projections that China will import a record quantity of crude oil this year as it comes out of Covid restrictions and lockdowns. Demand in the US could also surprise as well if the economy manages a soft landing. Brent crude oil prices surged by more than 7.5% overnight on the announcement, before profit taking pulled prices back after they hit significant chart objectives around the $80 per barrel mark.

Higher oil price bad for inflationThis could be bad news for the inflation/interest rate debate, as declining energy prices accounted for a significant portion of easing inflation pressures in recent months. Inflation in the service sector continues to grow, due to its dependency on a tight labor supply, but those pressures have largely been offset by declines in energy prices. We have previously warned about becoming too complacent about inflation in an environment where energy prices could rebound – and do so quickly – before wage inflation has been tamed.

The 10-year correlation between the StoneX Commodity Index and the five-year breakeven inflation rate fluctuates north of 0.80, which is a relatively strong correlation.

StoneX Commodity Index versus 5-year US Breakeven Inflation Rate

We tend to see an increase in money flow into the broader commodities when the market’s focus is on inflation, and it flows out when the market’s focus is on recession and declining inflation. The latter has been the case for much of the past year. Fund managers look at supply and demand fundamentals through a different colored lens when they’re focused on inflation than when they are focused on recession risks. Fed fund futures reflected roughly even odds of seeing another rate hike at the Federal Reserve’s May meeting on Friday, but those odds topped 60% earlier today.

Major markets flat

• At the time of writing, the broad S&P 500 index was flat at 4,116, while the tech heavy NASDAQ was off 0.7% at 12,143
• The VIX, Wall Street’s fear index, traded up to 18.9 reflecting more risky opinion
• The dollar index was modestly weaker at 101.8, with £/$ 1.24 and €‎/S 1.09
• Yields on 2- and 10-year Treasuries were unchanged at 4.06% and 3.43%, respectively

Oil and soft commodities stronger

• Crude oil prices were up 10.4% to $80.6 per barrel
•  Grain and oilseed prices found support Friday from supportive US Department of Agriculture (USDA) stocks, acreage reports and continued Chinese buying
• USDA’s surprise stocks numbers on Friday showed smaller-than-expected corn and soybean supplies
• We’re expecting US corn and soybean stocks to grow modestly in the year ahead, although global risks leave them vulnerable if overseas production falls short of current expectations

China war games a warning on US-Taiwan talks

• The Chinese army conducted intensive air and sea drills in the East China Sea over the weekend, while also commissioning new weapons and equipment
• The activity serves as a warning to Taiwan and to the US ahead of an expected meeting between Taiwan’s president and US House Speaker Kevin McCarthy in California this week
• Beijing responds strongly to any actions that it believes are intended to encourage Taiwan independence, which it sees as a threat to its national security

Analysis by Arlan Suderman, Chief Commodities Economist.

Read more of Arlan’s thoughts at StoneX Market Intelligence at https://my.stonex.com/