Oil prices are coming off the boil a little, with Brent crude retreating from its recent highs to trade just below $102 today. Despite the move, I wouldn’t mistake that for markets suddenly becoming comfortable with the energy story.
In part, the latest decline reflects some easing concerns over Saudi supply disruptions. And also, Saudi exports have been holding up better than feared – helping to cushion the blow.
There is also some noise from the futures market worth separating from the broader decline in oil prices. The oil curve remains heavily backwardated, meaning near-dated contracts are trading at a sizeable premium to later deliveries. That impacted WTI crude more so with the contract rollover having took place on 18 September, which saw a gap down on the price as the front-month oil exposure shifts from the October contract to the November contract.
In other words, the Brent crude fall is more to do with fundamentals but the steeper drop in WTI crude is arguably partly mechanical too.
Circling back to the big picture narrative, $100 oil is still the key psychological problem for broader markets. That matters more than whether prices are down a couple of dollars from their highs.
As long as oil prices remain around these levels, the inflation question doesn’t disappear. And the bond market has already shown how sensitive it is to that, with 10-year Treasury yields holding near the 5% level as investors reassess the inflation path and the Fed outlook. Central banks will have a tough balancing act to manage in needing to address their inflation mandate, but potentially risk hurting the economy.
And the longer this goes on, the tougher the situation will be.
Even with the latest drop, Brent crude has not yet fallen meaningfully on the charts.
The price has not yet even moved to test the 23.6 Fib retracement level of the swing higher from July to September at around $100.57. In this regard, I’d put more emphasis on the $100 level as being the more important “technical” and psychological level for trading sentiment.
Sellers will have to break back below the figure level to really convince of a further decline and dent to the narrative that higher oil prices are here to stay.
Otherwise, I would continue to watch oil prices and bond yields rather closely in the coming weeks.
A sustained move in Brent crude back below $100 would offer markets some breathing room. But staying above it keeps the inflation risk premium well and truly alive, and that remains an uncomfortable backdrop for bonds, equities and central banks alike.
This article was written by Justin Low at investinglive.com.