Head of Commodity Strategy
Summary: Crude oil suffered its largest one-day crash since April 2020 on Friday in response to worries the new omicron virus variant could drive renewed demand weakness at a time where the US is about to release millions of barrels of crude oil from its strategic reserves. While many have already concluded Friday's slump was an overreaction caused by thin market liquidity, the focus is once again squarely on the response from OPEC+ who will meet on Thursday to set production levels for January and potentially beyond.
Crude oil suffered its largest one-day crash since April 2020 on Black Friday in response to worries the new omicron virus variant could drive renewed demand weakness at a time where the US and other major oil importing nations are about to unleash millions of barrels of crude oil into the market from strategic reserves.
Equally importantly was probably the very bad timing with the news hitting the markets on a low liquidity day after the Thanksgiving holiday. Long held bullish conviction trades got stopped out as the sudden elevated level of risk aversion drove major position adjustments across most asset classes.
As volatility spiked, the options market also kicked into gear with hedging of short puts adding an additional layer of pressure with sell orders being executed at whatever price available. On Friday the 30-day historical volatility jumped from below 25% to 44% and it has ticked higher today, an indication of some unfinished business from Friday, but also a market which is struggling to settle down with Thursday’s OPEC+ decision adding an additional layer uncertainty.
So far today, the market is trading higher, but already off their overnight highs, but the reduction in hedge selling has allowed buyers to take a fresh look with some concluding the move on Friday was most likely an overreaction. Not least considering the prospect for support being provided by OPEC+ who may attempt to prop up prices when they meet this Thursday. The group may decide to postpone the January production increase or if necessary, temporary cut production into a period that was already expected to see the return of a balanced market.
Brent crude oil’s 11.6% top to bottom slump on Friday was only arrested when the price reached its 200-day moving average at $72.70 and after the price retraced 61.8% of the August to October surge. A key reason behind that run up in prices was driven by increased switching demand from record priced gas to cheaper oil-based fuels such as diesel, heating oil and propane. Following the drop in crude oil and continued strength in gas and power prices, the prospect for continued and rising switching activity will remain a key source of extra demand that did not exist during the 2020 slump.
Ahead of Thursday’s OPEC+ meeting the group has postponed their technical meeting, giving themselves more time to assess the impact of the new coronavirus variant on oil demand and prices. It comes at a time where the market in general is grappling with what to do about the omicron covid variant. The worst impact so far is from the speed with which countries are moving to halt inbound foreign travel, with many countries stopping all flights from South Africa and other countries in the region, while Japan has taken the dramatic step of halting all inbound foreign travel from tomorrow. More hopeful indications from virologists in the virus origin area are anecdotally that this variant is not particularly virulent, although others point out that too little is known about the virus’ effects on more vulnerable patients.
Goldman Sachs and Morgan Stanley have both in their latest updates calculated that based on no response from OPEC+, the market after Friday’s slump is now pricing in a 4 million barrels/day negative demand hit over the next three months. The impact during last winter’s second wave was around 2 million barrels per day. IF OPEC’s technical committee draws the same conclusion, the market could be in for a surprise production cut on Thursday.
The risk of 90-dollar oil has not gone away, but once again the timing has been postponed with 2022 increasingly looking like a relatively balanced year. The main worry remains 2023 and beyond when OPEC+ have exhausted their ability to increase production. Not least considering a potential decade of underinvestment's with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
