r-squared macro
August 23, 2016
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Oil Ends Bull Run

Market risk aversion and oil oversupply cause benchmark prices to ebb from their August rally.

What is driving oil prices lower?

Anticipation of U.S. rate hikes. Following last week’s minutes release and hawkish Fedspeak over the weekend, benchmark oil prices ended their 10% rally in August, falling 3% on Monday. If Chair Yellen’s speech this Friday bolsters hawkish Fed communication, risk aversion is likely to suppress oil prices into the near-term.

Worsening supply outlook. Although low prices have forced U.S. suppliers to cut production, August data indicate that oil’s recent bull run has prompted producers to reopen rigs. Furthermore, Iraq — OPEC’s second largest producer – announced that it will increase exports nearly 5%, following a resolution between the oil ministry and several large producers. These developments contribute to the souring global supply outlook.

What are the implications? 

Bellwether for risk sentiment.  Monday’s downturn in oil prices foreshadows an impending deterioration of risk sentiment. The Fed has been more cautious than expected this year, but a rate hike is still on the table before December. With oil supply outpacing demand, it is unlikely that benchmark prices will rebound in the coming weeks unless an external force (i.e. an excessively dovish Fed) salvages risk sentiment.

What lies ahead?

OPEC in September.  After failing to reach an agreement in June, investors shift focus to OPEC’s “informal” September meeting. Ideally, the continued fall in oil prices will pressure OPEC producers to cut supply. However, given OPEC’s previous inability to reach consensus, and the recent increase in Iraqi oil exports, it is unlikely that the bloc will yield from its aggressive stance. OPEC’s unlikely cooperation, combined with tighter Fed policy, paint a bleaker picture for oil prices than the recent rally suggests.

 

http://rsquaredmacro.com/oil-ends-bull-run/ 
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