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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Oil lower as yields rise and IEA talks down super-cycle risks
Ole Hansen
Head of Commodity Strategy
Summary: Crude oil continues to show signs of having reached its short-term potential with the current weakness being driven by a combination of rising US bond yields ahead of today's FOMC meeting and after the International Energy Agency toned down the potential for a tight supply driven super-cycle in crude oil.
What is our trading focus?
OILUKMAY21 – Brent Crude Oil (May)
OILUSAPR21 – WTI Crude Oil (April)
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Crude oil continues to show signs of having reached its short-term potential with the return to the lower end of its current range being driven by a combination of rising US bond yields ahead of today’s FOMC meeting and after the International Energy Agency toned down the potential for a super-cycle in crude oil.
In their latest monthly Oil Market Report, the IEA raised questions about some of the reasons that has supported Brent crude oil’s recent surge to $70/b. Especially the risk of a new super-cycle and a looming shortfall was given a cold shoulder. Not only do they see ample oil inventories despite a steady decline from the massive overhang that piled up during 2Q20. The also highlighted the hefty amount of spare production capacity, currently in the region of 8 million barrels/day that is being held back by OPEC+ members.
With the recovery in fuel demand still fragile, global demand look set to grow by 5.5 million barrels/day in 2021 according to averaged estimates from IEA, EIA and OPEC, and it will not return to pre pandemic demand levels before 2023. With these developments in mind it is clear that the 80% rally since early November, when the first vaccine news broke, has primarily been driven by OPEC+ withholding production.
In a couple of recent interviews I said that OPEC+ following their March rollover of production will have to increase production in April. Failure to do so could risk send the price of oil lower as the market would see that as a sign of continued demand weakness. Keeping production tight in order to send the price higher into a still weak demand outlook may prove to be counterproductive at this stage in the recovery.
Adding to the markets current unease is the relentless rise in US bond yields which has strengthened the dollar and inadvertently helped reduce the risk appetite across markets, not least commodities where speculators up until recently held a record long position across 24 major commodity futures.
Brent crude oil trades lower for a fifth day, its longest run of losses in six months. While resistance has been established above $70/b, support has yet to be established. Focus on the 21-day moving average, currently at $66.40 followed by $65, the trendline from the November low.
The weekly Commitment of Traders report from the U.S. CFTC breaks down the open interest in commodity futures between producers, swap dealers and money managers or speculators. In the latest update covering the week to March 9 we found that during the past four weeks the 12% rally in crude oil had triggered no additional increase in the combined speculative net long in Brent and WTI crude oil. While rising US bond yields and the stronger dollar, as mentioned, has lowered the general level of investment appetite, these developments also support our view that crude oil has reached a level beyond which can be hard to justify given current fundamentals.
Before today’s main event, the FOMC announcement at 1800 GMT, the US EIA will release its weekly crude and fuel stock report at 1430 GMT, also an hour earlier than normal due to US summertime. Given the result from last nights industry report from the American Petroleum Institute and surveys ahead of today’s release, the market is looking for a return to normal. This following the aftermath of the Texas freeze debacle which helped trigger two weeks of crazy data with refinery outages driven a surge in oil stocks and a record slump in gasoline and distillate stocks.
I will publish the results on my Twitter feed @ole_s_hansen, but with the focus squarely on today's main event, the FOMC meeting, the market impact is likely to be limited.
Earlier in the week I was invited onto the weekly Half-time Talk show organized by Gulf Intelligence in the UAE and published today Wednesday. During our 20 minutes conversation we talked about the super-cycle, what may drive it and more specifically took a closer look at current oil market fundamentals.
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