Crude Oil Prices Vulnerable as Central Banks Run the Risk of Inducing Recessions: Top Trading Opportunities

[MongiIG]

Jul 11, 2022 | DailyFX
Daniel Dubrovsky, Strategist

 

WTI crude oil prices have been rising swimmingly since a bottom was found at the peak of the 2020 global pandemic. Heading into the end of the second quarter, the commodity’s momentum slowed notably. Following the brief spike when Russia attacked Ukraine earlier this year, oil was around levels from early March.

June was on course for the worst monthly performance for WTI since November.

Have oil prices found a turning point? It is starting to seem so at the preliminary level. There is a reason the commodity is weakening: largely mistakes central banks have made in the fight against inflation.

Most notably, the Federal Reserve surprised markets with a 75-basis point rate hike after an unexpectedly strong inflation report in May. The Fed had to restore confidence in its ability to tame the beast. But, this is not an isolated case. What oil traders face heading into the third quarter is more aggressively hawkish central banks trying to tame inflation.

This comes at a cost: global growth.

The chart below shows the price of WTI overlaid with 2022 G20 growth expectations (YoY). At the beginning of this year, the economies of the group of twenty were seen expanding about 4.3% y/y on average. This has dwindled, particularly after Russia attacked Ukraine. Now, the G20 countries are seen growing by about 3%.

Are we finally seeing crude oil capitulate to crumbling output expectations? It would seem so. The initial slow response from central banks to tame high inflation means a more sudden and rapid push to tame runaway prices. This comes with consequences of going too far and inducing recessions. That does not bode well for crude oil, making for a tough environment heading into the third quarter.

HAVE OIL PRICES RAN TOO FAR?

Data Source: Bloomberg, Chart Prepared by Daniel Dubrovsky