If the developed economies of the US. Euro zone and UK fall into recession, oil demand will weaken. The oil price over recent weeks has begun to price that in, but has it gone far enough?
TECHNICALS:
WEEKLY CHART
The market’s medium-term rally over the last two years from the $40 supports (established by a succession of Prior Highs at the level) looks to be over.
First the diagonal trendline has been smashed.
Second, the two prior Highs supports at 87.15 and 92.58 have been broken…
The detail of the breakdown shows the emergence of a bear trend through a succession of bear patterns:
a small Double Top in April,
a bear continuation Triangle in May,
and most recently the powerful resistance from both Prior Lows ( 94.02 and 90.17) and the band of broken supports from Prior Highs (thus becoming resistances) 87.15-92.58.
(Also, the 50% Fibonacci resistance helped halt the market’s bull retracement yesterday)
The bear trend is now well-established.
FUNDAMENTALS:
The Oil market, for so long considered a one way bet for the bulls and potentially ruinous for western economies, no longer looks so sure-footed.
As the developed economies moved out of recession and the economies of China, India etc., continued to expand apace, the argument went that oil prices could only go one way. New oil reserve discoveries were deemed as not keeping pace with demand coming from the fast-growing and emerging economies. And as ever, OPEC made little effort to restrain the price by increasing output, as they sought to cash in on the bonanza.
Things have changed.
The Eurozone sovereign debt crisis remains unresolved, despite several bailouts. The crisis has spread to Italy and France, and though not with the same intensity that engulfed Portugal, Ireland and Greece, it has still forced both Italy and France to rush through austerity measures in an attempt to placate the markets.
But growth in the Euro zone, seen for so long as Teflon-coated, has at last begun to wilt under the strain with German Q2 GDP released earlier this week especially disappointing.
In the US, a self-inflicted default was avoided, and a deficit reduction plan adopted. But the AAA rating was lost, at least on S&P’s measure. The focus now is the underlying health of the US economy.
Recession has emerged as the main fear, now that the debt ceiling issue has been dealt with.
Although the US economy recorded growth in Q2, it was seen as very weak. The labour market continues to cause concern despite an improved Non-Farm Payroll report in August, but the housing market has yet to stage anything that resembles a convincing recovery.
If the US economy can not shake off its current malaise, or worse still, slips into recession, and the Euro zone cannot find the political cohesion to resolve the debt crisis, a period of economic under performance, or outright recession looks likely.
Global equity markets sense this and have been selling off over recent weeks, but of greater interest to us, is oil.
If the developed economies of the US, Euro zone and UK fall into recession, oil demand will weaken. The oil price over recent weeks has begun to price that in, but has it gone far enough?
We judge the oil price could fall further in the current environment:
·Equity markets are selling off hard as we write, and traders are registering their expectation of a new recession.
·The ECB is very active in markets pumping out liquidity and buying bonds.
·The Fed has signalled short-term US interest rates are on hold until 2013 and may start a 3rd round of QE.
·The UK Bank of England is unanimous in not wanting to raise interest rates even though CPI stands at 4.4%; they are worried about growth and are considering a 2nd round of QE.
·Watch the price action in this market as oil traders’ economic expectations catch up with reality.
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