On Monday, the front-month March 2025 Brent contract moved higher to trade just under $77.50/bbl at the time of writing. Some of the recent buoyancy in crude prices stemmed from the strength in physical Middle Eastern and Asian markets, with strong buying interest from China despite little indication of a resurgence of oil product demand. Iranian and Russian crude oil supply was also reportedly lower, likely aiding the demand for alternative crudes from China and India, respectively. The release of Saudi OSPs for February barrels did show increases in the price of flagship Arab light, but with significant divergence in the extra amount charged to European and Asia buyers, the latter seeing a more modest per barrel rise. In our view, this could indicate that recent strength is seen as transitory, and the Saudis want to keep the oil flow going as much as possible. The latest available commitment of traders data from ICE shows a pause in the increase of net length by money managers on Brent futures. At the same time, technical indicators suggest the price rally may be topping out. As the US completes the final step of the presidential election today with Congress counting electoral votes, we see three reasons for Brent futures to retrace recent gains by the end of the week to end in a range of $73-75/bbl.
- Plain old profit-taking
- China’s falling bond yields
- A Fed on hold
The front-month Brent futures contract gained over $5/bbl from the closing week of December to today in relatively short order, with sequential price increases pushing technical indicators into overbought territory. Brent is now hugging the upper Bollinger band, while the 14-day RSI is nearing the 70 mark. As measured by the MACD, momentum has yet to show an inflexion, suggesting there may be more upside in the short term – but the price action seems at odds with the latest positioning data. The net futures position of money managers provided by the ICE exchange on Brent futures declined in the week to 24/12/24 after consecutive weekly increases. The ICE exchange has yet to release data for the beginning of 2025, but if we see a second weekly change whereby again gross long positions are trimmed, and gross short positions incremented, we could be in for a bout of profit-taking this week, deflating a rally lacking a clear basis in flow or fundamentals.
On the macroeconomic side, trends in China will continue to be a bellwether for global oil demand growth. It would be unreasonable, in our view, to draw hasty conclusions from December PMI printing above the 50 threshold that separates expansion from contraction as an indication that fiscal and monetary stimulus efforts are bearing fruit. Such efforts take time. Last year, China was suffering from deflationary pressures. If these pressures were somehow reversed following recent stimulus measures, inflationary expectations should have picked up, and bond yields would be better supported. Instead, the generic 10-year Chinese bond yield has steadily declined and recently has sunk below 1.6%. In the meantime, the PBoC has vowed to cut the reserve requirement ratio (RRR) of commercial banks and policy rates at the “appropriate time”, echoing a request that came from the Central Economic Work Conference – when that will happen is yet to be determined as the central bank also shows its desire to defend the yuan. In the meantime, China pessimism could easily grip sentiment again, helping to strengthen the case for the aforementioned bout of profit-taking.
Following the latest FOMC and downgrade in the median dot plot, the Fed is in no rush to cut rates, reinforcing the US yield difference notably with Europe and keeping the US dollar strong. Strength in the USD does not systematically involve a correction in commodity prices but will continue to act as a headwind. This Friday’s release of non-farm payroll data (NFP), if in line with or better than expectations amid a steady jobless rate, could seal the deal on the Fed’s willingness to hold out longer and prove to be a bearish event risk for oil prices at the end of this week. The December NFB print will likely see some manufacturing decline but gains in services and government sectors, the extent of which in services is likely to be determined by how post-election enthusiasm has been generated. Ultimately, unemployment needs to rise well above 4.3% before we see the Fed deviate from its current policy course.
