Oil prices have recently experienced a notable surge, marking a shift from their extended stay in bearish territory. A combination of OPEC+ committing to output reductions, a substantial withdrawal from crude oil inventories, and optimism regarding the potential of a soft landing for the global economy appear to be the primary driving forces behind this rally. This optimism, however, appears to ignore the plethora of bearish factors that remain in play in today’s oil market.
Over the past six weeks, both Brent and WTI have seen significant gains of 15.4% and 18.2%, respectively. A central factor contributing to this upswing is OPEC+’s ongoing commitment to reducing production. This development can be analyzed in two ways. On one hand, the persistence of production cuts implies impending supply constraints, thus signaling a bullish trend. On the other hand, these supply reductions stem from concerns surrounding oil demand. As elucidated in my recent article, there is plenty of reasons to interpret these output cuts as bearish rather than bullish.
Clear indications of a global economic slowdown are emerging, yet these signals are conveniently being disregarded by oil bulls. For instance, the US non-manufacturing PMI dropped from 53.9 to 52.7 in June. Concurrently, the manufacturing PMI has sustained a nine-month downward trajectory – a streak of losses unseen since the 2008 Financial Crisis. The Conference Board’s Leading Economic Index (LEI) accentuates this downturn, recently sliding from 106.9 in May to 106.1 in June – an unprecedented 15-month consecutive decline, marking the lengthiest continuous decline since 2009.
Economic activity in the Eurozone is similarly facing a decline. The region’s economic performance has suffered a significant blow in recent months, evidenced by a sharp decrease in business output. The HCOB flash PMI, a pivotal indicator for business output, has revealed a noteworthy drop, signifying the most substantial contraction over the past eight months, starting from July. The Flash Eurozone Composite PMI Output Index dwindled from 50 in June to 48.9 in July, reflecting a second successive reduction in activity following five months of growth.
The Eurozone’s PMI has fallen to 42.7 from June’s 43.6, compared to 49.3 last year.
New orders have plunged to levels unseen since 2009, while service sector orders experienced their initial decline in seven months. The slowdown has also manifested in labor markets, with work backlogs hitting their lowest point since February 2013.
Germany, the cornerstone of the European economy, continues to grapple with significant challenges. The economy contracted by 0.1 percent in the first quarter of 2023, alongside its manufacturing PMI plummeting to a 38-month low of 41. Drastic declines in new work orders, owing to reduced demand and weak economic activity, have been observed. Job creation has also been severely impacted, now at its lowest point in two years.
China, the world’s second-largest economy, has consistently disappointed investors and analysts as its post-COVID reopening failed to gain momentum. The country recently reported another widespread decline in business activity, with its PMI reaching 49.3 in July-marginally higher than June’s 49. Since March 2022, the index has indicated contraction (below 50) for 12 out of the 17 months thus far.
Moreover, the various measures aimed at stimulating growth within China have proven insufficient.
In light of these compelling indicators, it becomes evident that the global economy is treading toward a recession. Given these circumstances, the production cuts should not be interpreted as a sign of supply shortage; rather, they underscore the concerns that contribute to an imminent decline in demand. Consequently, the ongoing oil price rally is likely temporary. I project a ceiling of around $90, with substantial resistance likely around $85. The likelihood of the US entering a recession increases as we approach the end of 2023. The global market sentiment currently appears muddled-an aspect I monitor through the Market Sentiment Tracker for Primary Vision Network.
I anticipate that bearish sentiment will soon prevail, coupled with profit-taking, ultimately causing oil prices to plummet to the lower $70s or mid $60s. My expectation is that oil prices will reach the lower $60s before the year concludes.
By Osama Rizvi for Oilprice.com