Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Surging crude oil in need of consolidation
Ole Hansen
Head of Commodity Strategy
Summary: The energy sector led by crude oil continues its month-long rally, thereby supporting the recent jump in government bond yields in anticipation of even tougher action by the US Federal Reserve to curb inflationary pressures. As a result, energy sector stocks and ETF’s have avoided the sell-off hurting other sectors, not least the tech-heavy Nasdaq index. However, in the short-term, an elevated RSI above 70 and continued trading near the upper Bollinger band points to a need for consolidation
The energy sector led by crude oil continues its month-long rally, thereby supporting the recent jump in government bond yields in anticipation of even tougher action by the US Federal Reserve to curb inflationary pressures. As a result, energy sector stocks and ETF’s have avoided the sell-off hurting other sectors and not least the tech-heavy Nasdaq Index. Developments highlighting the fact that while surging bond yields may hurt interest rate sensitive stocks, the so-called old economy stocks are alive and well with the supply of crude oil, some partly due to temporary disruptions, struggling to keep up with current strong demand.
Besides the surging omicron having a much smaller negative impact on global consumption it’s the realization that several countries within the OPEC+ group are struggling to raise production to the agreed levels that has been driving the energy sector futures and stocks higher in recent weeks.
For several months now we have seen overcompliance from the group as the 400,000 barrels per day of monthly increases wasn’t met, especially due to problems in Nigeria and Angola. However, recently several other countries, including Russia have struggled to increase production further. The International Energy Agency in their just published monthly Oil Market Report said that the OPEC+ coalition managed only 60% of its planned increase in December while S&P Global Platts estimated the accumulated daily shortfall in December had risen to 1.1 million barrels per day.
As expected, the IEA also lowered previous forecast for supply surpluses during the first and the second quarter after saying that the global surplus is shrinking and oil demand is on track to hit pre-pandemic levels. The Covid pandemic is once again causing record infections, but this time round, the surge is having a much more muted impact on demand. In addition the IEA also mentioned the current gas crisis which has led to an increased amount of gas-to-fuel switching.
Following a 5.5 million barrels a day increase in global oil demand in 2021 the IEA sees demand growing by 3.3 million barrels this year and with spare capacity being run down courtesy of the OPEC+ gradual production increases, the remaining spare capacity may end up being concentrated in a few Middle Eastern producers and the US.
This week Brent and WTI crude oil both broke their recent cycle highs with current levels not seen since 2014. The breakout has increased focus on $90, a level Goldman Sachs says could be reached in the second half, and even $100 per barrel with some OPEC members believing that could be a possible target given the outlook for tight market conditions during the coming months and even years.
Momentum remains strong and open interest in both futures contracts are showing a healthy rise while speculators, a bit late to the recent rally, boosted bullish oil bets in WTI and Brent bets by the most in 14 months in the week to January 11. The combined net long—the difference between bullish and bearish bets—in Brent and WTI jumped during that week by the most since November 2020 to reach 538,000 lots or 538 million barrels. This is still well below the most recent peak at 737,000 lots from last June.
In the short-term, an elevated RSI above 70 and continued trading near the upper Bollinger band points to a need for consolidation. If triggered, the initial support will be the recent highs, $86.75 in Brent and $85.50 in WTI. Given the strength of the recent rally, both contracts can correct around 10% without putting the prospect for further upside gains into doubt.
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