Oil prices cause concern

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Written by Citadel Global Director, Bianca Botes.

The surge in oil prices, driven by supply concerns, geopolitical factors, and energy transition dynamics, poses significant challenges to both central bankers and global markets.

Key themes for this week include:

  • Oil prices at one-year highs
  • High oil prices and elevated Treasury yields keep Wall Street subdued
  • Dollar remains dominant

OIL PRICE REIGNITES INFLATION WOES

The recent surge in oil prices driven by a confluence of factors saw Brent Crude futures hitting a near-one-year high of $97.80/barrel. Firstly, a sharp 2.2 million barrel drop in United States (US) crude inventories, far exceeding market expectations, has raised concerns about tight global supply. Cushing, Oklahoma, a crucial US storage hub, witnessed its crude stocks plummeting to their lowest levels since July 2022, due to strong refining and export demand, which has further exacerbated market concerns.

Secondly, the expanded Organisation of the Oil Exporting Countries’, OPEC+’s major players, Saudi Arabia and Russia, have extended supply cuts through to the year’s end, intensifying worries about tightening global supply, particularly as the West approaches its winter. Adding to this, the Russian government is contemplating restrictions on grey fuel exports and increased fuel export duties for resellers.

The implications of these rising oil prices are multifaceted. Notably, they contribute to persistent inflationary pressures, because as oil prices rise, they push up production costs across various industries, from transportation to manufacturing. These increased costs are often passed on to consumers in the form of higher prices for everyday goods, which of course, in turn, contributes to elevated inflation, an issue which central banks must grapple with. In 2020, central banks celebrated the decline of oil prices from $120/barrel to $70/barrel. Now, however, increased oil prices are going to hamper their ability to reach the 2% inflation targets.

In addition, the intricate interplay between energy markets, inflation, and global economic stability is a critical concern. As the world navigates an energy crisis – which is being amplified by the shift towards green energy, as well as geopolitical realignments following Russia’s invasion of Ukraine – Europe, a major energy importer, finds itself vulnerable to supply disruptions, especially as oil prices surge. The euro’s weakness, in the face of rising oil prices, adds another layer of complexity to the situation, as it affects the cost of imported goods and the region’s overall economic stability.

Given these market complexities, the recent price increase highlights the need for careful monitoring and policy responses to navigate these dynamics.

KEEPING UP WITH OTHER COMMODITIES

Gold remained below $1,880/ounce, near a six-month low, due to a strong US dollar and rising Treasury yields linked to expectations of prolonged higher interest rates. The US Federal Reserve (Fed) hinted at another rate hike this year and fewer cuts in 2024. Investors are watching for US Gross Domestic Product (GDP), jobless claims, and the Personal Consumption Expenditures (PCE) Price Index report for economic insights.

Platinum futures dipped to around $900/ounce amid concerns of reduced demand after the Fed’s hawkish tone. However, China’s stimulus and stricter emission standards, which has boosted platinum use in auto catalysts, along with robust economic data, is supporting prices. South Africa, as the world’s largest platinum producer, has also seen a slight ease in its power issues. The platinum market is expected to face a deficit this year, with demand surging by 27%, while supply remains stable.

Palladium futures fell to approximately $1,200/ounce, their lowest level since 2018, due to demand worries and a strong US dollar. Increased production of heavy-duty vehicles using platinum and the growth of electric vehicles in China have reduced palladium’s role in reducing emissions. Expectations of sustained higher global interest rates have also weighed on palladium demand. Palladium prices are down 43.5% year-on-year.

A LOOK AT THE DATA

In August 2023, US new single-family home sales fell sharply by 8.7% to an annualised figure of 675,000, missing the market’s expectation of 700,000. This decline was largely due to rising mortgage rates, reflecting the Fed’s aggressive interest rate hikes. However, in a surprising turn, new orders for durable goods in the US rebounded unexpectedly by 0.2% in August, following a 5.6% slump in July. The US economy maintained a 2.1% annualised growth rate in the second quarter of 2023, with consumer spending coming in lower than anticipated at 0.8%. Unemployment claims in the US saw a modest increase of 2,000 to 204,000, indicating a tightening of the labour market, yet still allowing for the potential of a rate hike in November.

In the euro area, the economic sentiment indicator for September 2023 slightly declined to 93.3, down from the revised 93.6 recorded in the previous month. However, it exceeded market expectations of 92.5, marking the lowest reading since November 2020. This dip is attributed to persistent inflationary pressures within the eurozone and the European Central Bank’s (ECB’s) ongoing policy tightening, which has dampened overall economic morale.

Shifting to South Africa, the composite leading business cycle indicator grew by 0.1% month-on-month in July 2023, following a revised 0.2% uptick in the previous month. This represents the second consecutive month of improvements in business indicators after four months of decline. Positive contributions came from increased job advertisement space and average hours worked per factory worker in manufacturing. However, these gains were offset by a decrease in South Africa’s export commodity price index, denominated in US dollars, and a slowdown in the growth rate of new passenger vehicle sales. Meanwhile producer price inflation accelerated to 4.3% year-on-year in August 2023, up from July’s 2.7%. This exceeded market expectations and marked the end of a 12-month decline. The acceleration was primarily driven by increases in metals, machinery, equipment, and computing-equipment prices.

Finally, profits earned by China’s industrial firms declined by 11.7% year-on-year to ¥4,655.82 billion in the first eight months of 2023. This decline reflects weak demand both domestically and internationally, as well as ongoing margin pressures. The decrease affected both state-owned and private sector firms, with state-owned firms experiencing a smaller decline in profits compared to the previous period.

OIL PRICES AND TREASURY YIELDS KEEP EQUITIES SUBDUED

In the oil market, West Texas Intermediate Crude futures dipped toward $89/barrel for the third consecutive session. This decline followed a hawkish stance from the US Fed. Concerns about global economic growth and energy demand emerged as a result. US crude inventories dropped by 2.135 million barrels, aligning with expectations. Oil prices, despite this dip, remain close to multi-month highs, mainly due to forecasts of a wider market deficit in the fourth quarter due to extended supply cuts from Saudi Arabia and Russia, along with declining US oil output from major shale-producing regions.

In the US, stocks dipped slightly on Thursday, with the S&P 500 and Dow Jones down nearly 0.1%, and the Nasdaq slipping 0.3%. Rising Treasury yields and high oil prices have fueled concerns about prolonged higher interest rates. Economic data offered mixed signals, with second quarter GDP at a steady 2.1% but with a notable cut in consumer spending. Investors are closely monitoring the political deadlock over another potential US government shutdown and hawkish statements from Fed Chair, Jerome Powell, as well as other policymakers. In corporate news, tech shares, Apple, Microsoft, and Nvidia fell about 1%, while exercise equipment manufacture and media company, Peloton, rose 4% due to a partnership with athletic apparel company, Lululemon.

In the United Kingdom (UK), the FTSE 100 hovered around 7,590, driven by concerns about surging energy prices, which are contributing to worries of prolonged elevated inflation. Brent Crude surpassed $97/barrel, raising fears of broader inflationary pressures and extended central bank restrictions. The world’s largest real estate developer, Evergrande’s trading suspension in Hong Kong added to concerns, affecting London-exposed stocks. Financial services firm, Prudential and Mexican precious metals group, Fresnillo, declined, while petroleum giants, BP and Shell share prices increased.

European stock markets showed signs of recovery, thanks to Germany’s lower-than-expected 4.5% inflation rate in September. However, Spain’s inflation rose to 3.5%, its highest level since April. In corporate news, multi-energy, Total Energies finalised a sale to Malaysian energy group, Petronas, while low-cost airline, Ryanair, adjusted its winter schedule due to Boeing delivery delays. Betting company, 888 Holdings, lowered its annual profit expectations after a 10% third quarter revenue decline.

In Japan, the Nikkei 225 fell 1.54% to close at 31,872, and the broader TOPIX Index dropped 1.43% to 2,346. This was driven by surging oil prices and Japanese government bond yields denting risk sentiment. Japanese Prime Minister, Fumio Kishida, instructed his cabinet to develop a new economic package to address rising inflation and to support the struggling economy.

In South Africa, the JSE All Share Index held steady around 72,260, with inflation and higher interest rate expectations influencing cautious investor sentiment. South Africa’s producer inflation increased to 4.3% in August, surpassing expectations. Tech companies, gold miners, and industrials lagged, while retailer, Spar Group reported strong trading performance, leading to a nearly 8% increase in its shares. Capitec Bank also saw its shares rise over 5% after reporting a 9% increase in half-year profit.

EURO SLIPS TO 9 MONTH LOWS

The US Dollar Index, despite early gains, dipped to around 106.3 on Thursday, remaining close to the 10-month high of 106.839 reached on Wednesday. Investors analysed the impact economic data is having on the Fed’s monetary policy. The US 10-year Treasury note yield surged to 4.65%, its highest level since July 2007, raising concerns about prolonged high interest rates. Rising US national debt and the 1 October budget deadline has added pressure to Treasury prices.

The euro traded near $1.05/€, approaching the lows of December 2022. A weaker euro is being influenced by a strong dollar due to the hawkish Fed and expectations of prolonged high US interest rates. Euro area inflation showed mixed trends, with Germany’s slowing more than expected, while Spain’s continued to accelerate. Rising oil prices have added to concerns of potential sticky inflation. Market sentiment leans toward the ECB avoiding further rate hikes this year, though rates are expected to stay elevated.

The British pound slipped below $1.22/£, reaching its lowest level since mid-March. Weak economic data and the Bank of England’s rate pause affected investor sentiment. The PMI report indicated a significant contraction in UK September’s business activity due to cost-of-living pressures and higher borrowing costs. UK policymakers are expected to keep the bank rate at 5.25% in November, given signs of slowing inflation.

In South Africa, the rand weakened to a three-month low against the dollar, while government bond yields reached record highs, due to concerns about the country’s fiscal outlook and global risk aversion. The rand also saw its longest losing streak in six weeks, touching its weakest level since June at around R19.20/$ before partially recovering to trade 0.5% stronger at R19.08/$ towards the local session’s close on Thursday, and sustaining a strengthening path in overnight trade. Yields increased across the curve, with the year 2035 securities surpassing 12.5% for the first time.