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Oil price today: View: Oil prices and financial markets brace for recession

by Ozva Admin
US economic data remains strong, but a number of financial indicators point to a sharp slowdown over the next year that would curb oil consumption and lead to lower prices.

The apparent contradiction between the real economy and financial markets has puzzled some commentators, but it is normal around a peak in the business cycle.

Economic data reflects current conditions, while financial prices reflect how traders expect the economy to perform in the future.

By definition, every recession starts from a peak in the business cycle when activity is strong. The rapid change from strong and growing economic activity to contraction is what makes turning points difficult to predict.

In recent decades, the largest forecasting errors have occurred around turning points, especially peaks (“Business Cycles: Theory, History, Indicators, and Forecasting,” Zarnowitz, 1992).

But financial markets currently assign a high probability to a significant slowdown in the cycle in the next 6 months, possibly qualifying as a recession, despite the high level of economic activity and employment.


PEAK ACTIVITY?

World trade volumes and industrial production remained at or very close to record levels in June, according to the Netherlands’ Office for Economic Policy Analysis (“World trade monitor,” CPB, Aug. 25).

US freight volumes hit record levels in June and manufacturing output was near its highest levels since before the financial crisis, according to data from the US Bureau of Transportation Statistics and the Federal Reserve. .

Manufacturing activity continued to increase through August, although more slowly than before, according to surveys conducted by the Management and Supply Institute.

The ISM Composite Purchasing Managers’ Index stood at 52.8 in July and August, slightly above the 50-point threshold that divides expanding activity from a contraction, and in the 50th percentile for every month since 1980.

But a wide range of financial indicators across fixed income, equity and commodity markets, as well as individual share prices of pioneering companies, point to a significant slowdown in the cycle over the next six months.

EXPECTED SLOWDOWN

Futures prices imply that the US central bank is expected to raise interest rates over the next six months to 4.25-4.50 percent before April 2023 from 2.25-2 .50 percent today, impacting borrowers and the economy.

The US Treasury yield curve between two-year and ten-year maturities is more inverted than at any time since August 2000, when the dot-com bubble began to burst.

Financial conditions are tightening at some of the fastest rates in more than a decade, according to the Chicago Fed’s index of financial conditions, which is based on measures of risk, credit and leverage.

US stock indices have already tumbled as investors anticipate a recession that will hit demand and further discount future earnings.

After adjusting for inflation, the broad US S&P 500 stock index is down about 13-14 percent compared to the same period last year.

Individual stocks closely tied to the cycle, including heavy-equipment maker Caterpillar and diversified manufacturer 3M Corporation, have fallen sharply, in line with a significant economic slowdown.

South Korea’s KOSPI-100 index, which tracks the global business cycle due to its large exposure to export manufacturing companies, is also down more than 23 percent from the same point last year.

DIESEL MARKETS

The expected slowdown in the economic cycle is evident in fuel markets, where the spread between Brent crude oil and European gas oil futures for delivery in April 2023 has softened to $30 a barrel from more than $40 at the end of August.

The calendar spread for diesel between December 2022 and December 2023 has fallen to a reversal of $12 per barrel from $26 in late August and $33 in June, implying that inventories are expected to be higher than before.

Diesel and other middle distillates are the workhorse of freight manufacturing and transportation and the most sensitive to changes in the business cycle.

The softer spreads are consistent with a regional and global slowdown that would allow distillate inventories to rebuild from their current very low level.

ANALYSIS EXPECTATIONS

Bond, stock and commodity prices reflect what is expected to happen, not what will happen, and those expectations could change or turn out to be wrong.

But financial markets assign an unusually high probability to an impending recession right now, so expectations cannot be dismissed lightly.

In the event of a significant cyclical downturn, it is likely to be more severe in Europe and China than in the United States.

Europe is more directly exposed to the consequences of high energy prices, high inflation and the possible interruption of gas supplies stemming from the Russian invasion of Ukraine.

China is struggling with a persistent cycle of city-level lockdowns imposed to stem the spread of the coronavirus as part of its epidemic control strategy.

But spillover effects from Europe and China, as well as a massive tightening of domestic financial conditions, are expected to cause a significant slowdown in the US itself.

Slower growth in the big three economies will also spread to the largest emerging economies, including India, Brazil, Saudi Arabia, Indonesia, Turkey, Mexico and Thailand.

If the expected slowdown materializes, energy consumption will grow much more slowly in 2023, taking some of the heat out of coal, gas, diesel and crude oil prices.

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