Oil prices rose yesterday as Israel promised to retaliate against Iran and the G7 leaders announced that they are preparing to impose fresh sanctions on Iran. But the topside in US crude rally remained capped near the $72.85pb level, the major Fibonacci retracement on the July to September retreat, and that should, in theory, distinguish between the actual bearish trend and a medium-term bullish reversal.
I know I insist but I find the US crude’s inability to clear this technical resistance interesting and informative. It tells me that the geopolitical tensions do attract tactical longs, but the conviction for reversing a medium-term trend is still not strong enough. Look, we saw yesterday’s gains rapidly given back after the EIA data showed a 3.9-mio barrel build in US oil inventories last week.
Now, note that some bullish voices are emerging, putting the $100 per barrel target back on the table. But I believe that we will hardly see the barrel of US crude go past the $88-90pb range in case of the badly deteriorating situation in the Middle East, because OPEC is preparing to call the end of its production restrictions by the end of the year as Saudi is moving toward a strategy where it will try to increase its market share rather than supporting oil prices.
And second, around half to two-thirds of the Iranian oil goes mainly to China – which is not concerned by the sanctions. The only thing that could materially extend crude oil’s topside is if the US-backed Israel attacked the Iranian oil facilities. That’s the biggest risk to the global oil supply and that’s – to me – the only scenario which would justify a rise in crude prices to $100pb or more. And even then, imagine what would happen to the Fed – and other major central banks’ – inflation expectations and loosening policies.
A significant rally in energy costs would simply stop and reverse them – which in return would boost the global recession expectations and limit oil’s upside potential. What I am trying to say is that, the geopolitical tensions could be interesting tactical opportunities for the oil bulls, but the medium-term picture remains comfortably bearish.
Geopolitical Situation Worsening
The geopolitical situation in the Middle East gets tenser, and the Federal Reserve (Fed) doves get worried with the sight of better-than-expected jolts and ADP report announced earlier in the week.
Yesterday’s ADP report showed that the US economy added around 142K new private jobs last month, comfortably higher than the 124K penciled in by analysts. Last month’s figure was revised higher. The numbers are not near 200-300K job additions of the post-pandemic months – far from that – but we are not seeing the kind of numbers that would keep the expectation of another jumbo rate cut from the Fed in November either.
The US 2-year yield is pushing gently above the 3.60% level, having bottomed near the 3.50% last week when the 50bp cut expectations for November have surfaced, the 10-year yield recovered to 3.80% and the US dollar broke above its negative trend top building since summer and is preparing to test the 50-DMA.
The last test for the US dollar bulls is tomorrow’s official jobs data. If the data continues to show that the US jobs market is slowing but not collapsing, we shall see the US dollar recover further.
The broadly stronger US dollar, combined with a slide in the euro area inflation below the European Central Bank’s (ECB) 2% inflation target justifies a further selloff in the EUR/USD. The pair took out the 50-DMA support and is now preparing to test the next, and the important psychological support of $1.10 level. Below that, at 1.0980, stands the major 38.2% Fibonacci retracement on June to September rebound, and should distinguish between the positive trend building since summer and a medium-term bearish reversal.
And of course, the sharp yen selloff in the Japanese yen is giving additional support to the US dollar following the new PM Ishiba’s comments that the Japanese economy is ‘not ready yet for further rate hikes’ and hopes that the ‘economy will make progress n a sustainable manner toward the end of deflation with the monetary easing trend in place’.
The USD/JPY was sent immediately above the 146 level. We can forget a sustainable fall to and below the 140 mark. There is a greater chance that we see the pair return and stabilize near the 148/150 level.
Now, a better-than-expected set of US jobs data is positive for the US dollar bulls and negative for the US treasuries, but it is not outright positive or negative for sentiment in the stock markets. Yes, the Fed cuts are supportive of valuations and the 50bp cut has provided a lot of joy to stock investors, but a collapsing jobs market is fundamentally bad news for the economy. So the impact of possibly stronger-than-expected jobs data on Friday is difficult to tell.
On one hand, a good set of data would confirm that the US economy is doing well enough to keep the S&P 500’s profit expectations strong and give a further support to stock valuations near ATH levels. On the other hand, a too-strong set of data would crash the expectations of further and aggressive rate cuts from the Fed and that’s mathematically unfavorable for the stock valuations.
Investors’ opinions diverge. Many think that the 6000 for the S&P 500 is not only within reach but is too easy to reach, while a few others – like Apollo’s CEO - think that the Fed has no reason to keep cutting rates and that its aggressive U-turn could backfire. After all, the US ports went on a strike this week, oil bulls give signs of life as a result of a widening war in the Middle East and the Fed may have declared victory on inflation earlier than ideal, and probably louder than reasonable.