It’s supposed to be the week when assets from stocks to commodities get supercharged from “rate cut excitement”.
Yet, it certainly doesn’t feel that way with oil.
Demand worries are continuing to haunt black gold despite prospects of the first U.S. rate cut in a decade that could be a boon for commodities.
In Monday’s session, crude oil futures began the day weaker as Japan forecast weaker economic growth in a sign of greater fallout from the U.S.-China trade war. Oil bulls also took a hit, initially, from an easing of geopolitical tensions over Iran, as the Islamic Republic sat in cordial talks with Western powers over its nuclear future.
Both West Texas Intermediate crude and London’s Brent, the benchmark for oil outside of the U.S., eventually settled Monday’s session higher as traders rallied around the notion of at least a quarter percentage point cut from the Federal Reserve this week.
Tuesday’s trading also opened in relatively positive conditions in Asia.
Nagging Feeling That Oil Could End Week Lower
But there remains a nagging feeling that whatever gains oil tacks on could be dwindling by the end of the week, as demand worries continue to tug at the market’s underbelly.
Phil Flynn, senior energy analyst at Chicago’s Price Futures Group and a well-known oil bull, put it most succinctly during Monday’s early trading in New York, when the market was down:
“Oil is stuck on the backburner as the markets all wait for the outcome of the U.S.-China trade talks.”
“And, of course, the Fed decision is looming large, where it is widely expected that the Fed will cut rates for the first time since 2008.”
“All that macro-economic anticipation is reminding us that oil prices are focused on global growth ideas for market direction.”
Expectations that the Fed will cut rates by at least 25 basis points at its July 30-31 policy meeting powered a solid run across markets this month, helping gold futures hit six-year highs above $1,450 at one point.
And while WTI and Brent are headed for their second month of losses in three, both averted some of their worst downside in July on buying support linked to speculation over the rate cut.
The Fed’s decision will likely overshadow other policy announcements this week by the Bank of Japan and the Bank of England, which are both expected to stay on hold.
The European Central Bank’s decision to hold rates last week gives the BoJ some breathing room amid a shift to a more dovish stance by central banks worldwide.
Without making a move, the BoJ may reinforce its commitment to keep interest rates at record lows, while the BoE may offer its assessment of the British economy's current downturn, and how it might respond in the event of a hard Brexit.
That aside, the U.S. jobs report for July, along with Chinese, U.S. and euro zone manufacturing PMI, among others, make for a data-heavy week that again pits concerns about the global economy versus official policy responses.
In the latest sign of a global slowdown, Japan slashing its economic growth forecast for this year—largely due to weaker exports—corroborated fears the protracted U.S.-China trade war is taking a bigger toll on the world's third-largest economy.
The International Monetary Fund recently cut its own global growth outlook, while European Central Bank President Mario Draghi said last week that prospects for the euro zone economy were getting “worse and worse”.
Diminishing Iranian Tensions Not Helping
On Iran’s nuclear talks, Abbas Araqchi, a senior negotiator for the Islamic Republic, called the discussions with parties in Tehran's 2015 deal with global powers “constructive”, with “lots of commitments” and “good” discussions.
If tensions over Iran ease further or if Tehran manages to strike a new nuclear deal with the Trump administration to suspend sanctions on its oil, there are concerns that up to 2 million barrels per day of additional crude could enter the market, negating OPEC production cuts and adding to current oversupply.
Moreover, markets had sent odds soaring for a full 50 basis point Fed cut in the middle of July, but a string of better-than-expected data, including last Friday’s release of second-quarter GDP, has dampened those hopes.
Overall though, more important than what happens on Wednesday is what the market expects of the Fed in follow-through action in September and beyond. Here’s where the real disappointment could be for longs on commodities, as the Fed might not be as dovish as many expect.
After Rate Decisions, It’ll Be Back To Trade Talks
Some think Fed Chairman Jerome Powell could still spur an extended rally in oil and gold with what he personally says about monetary policy after the release of the central bank’s official statement on Wednesday.
TD Commodities said in a note:
“Considering that markets have already priced in a 25bp cut, we suspect that the focus will be on Powell's presser (news conference) which could still maintain a dovish tone given that global growth woes could continue to pressure the U.S. economic engine."
Commodity bulls are also keeping an eye on high level trade talks between the U.S. and China which restart on Tuesday in Shanghai, after they broke down in May. Expectations are low for any significant progress to be made, and a continuation of a long drawn-out process could, at best, benefit safe-haven buys like gold.