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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Crude slumps amid technical selling and recession fears
Ole Hansen
Head of Commodity Strategy
Key points
- Yesterday Brent dipped below USD 70 for the first time in over two years, while WTI reached a December 2021 low
- Led by a surge in speculative short positions amid sluggish demand and strong non-OPEC+ production
- Some investors have entered the sell side in order to protect other investments from the rising risk of a recession
- A record low belief in higher prices could be crude's best hope for staging a recovery
Crude oil’s decline continued on Tuesday before staging a modest rebound, as speculative selling exacerbated concerns over weak demand. Brent dipped below USD 70 for the first time in over two years, while WTI reached a December 2021 low, nearing USD 65 per barrel. Earlier in the week, global commodity traders Gunvor and Trafigura suggested that Brent prices could fall back into the USD 60s, citing sluggish demand from China and persistent global oversupply.
Last week’s OPEC+ decision to delay a planned October production increase by two months, combined with weak global manufacturing data and a technical market breakdown, contributed to a surge in speculative short positions amid soft demand and strong non-OPEC+ production. OPEC’s struggle to forecast global demand was evident in their latest Monthly Oil Market Report, where they maintained a 2024 demand growth projection of over 2 million barrels per day—more than double the EIA’s forecast in its Short-term Energy Outlook. The IEA, which in July projected demand growth at around 0.97 million barrels per day, is set to release its updated Oil Market Report on Thursday.
For now, crude’s ability to stage a rebound will depend on several factors, not least next week’s FOMC meeting and the dollar’s response to an expected rate cut. From a technical perspective, a major round of short-covering is unlikely to materialise unless Brent breaks back above USD 75 and WTI above USD 71.50.
As the above chart highlight, the recent move is not that significant from a recent historic perspective, but having seen the market trade sideways for the more than two years, the risk of a downside extension has forced a great deal of repositioning by traders and investors, some entering the sell side in order to protect other investments from the rising risk of a recession. A substantial flattening of calendar spreads during the past month are consistent with market behaviours ahead of an incoming recession which normally leads to a strong inventory build-up. The canary in the coalmine has been the recent drop in refinery margins amid rising inventories and soft demand for refined fuel products, especially diesel.
In the latest reporting week to September 3 - the day Brent crude slumped below USD 75 and two days before OPEC+ scrapped plans to increase production from October - large speculators held a record bearish position in the four WTI and Brent futures contracts traded on the exchanges in New York and London. The 139,000 contract net long was the lowest recorded belief in higher prices since 2011 when the ICE Exchange Europe joined the US CFTC in collecting weekly positioning data. In the last three weeks alone the net long was cut by 43% on a combination of 41k contract long liquidation and 62k contracts of new short positions.
The negative sentiment extended to refined fuels, with extremely bearish positions seen across gasoline and especially NY ULSD and London gas oil, two diesel and middle distillate contracts. Overall, these extremes not only highlight the negative technical picture supporting buy-into-strength strategies, but also traders using energy as a hedge against recession, amid signs of downturn in manufacturing across the U.S., Europe and recently not least China.
As we highlighted on several occasions, hedge funds tends to anticipate, accelerate, and amplify price changes that have been set in motion by fundamentals and supported by technical price developments. Being followers of momentum, this strategy often sees this group of traders buy into strength and sell into weakness, meaning that they are often found holding the biggest long near the peak of a cycle or the biggest short or weakest long position ahead of a through in the market.
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