The oil market is already exceptionally tight, with inventories being drawn down to meet demand as summer travel ramps up, and restricting supply any further leaves only one escape valve - higher prices. Consumers are already feeling the heat from surging oil prices and the rally isn’t slowing down despite lockdowns in China and the turmoil in stock markets.
Ultimately something has to give - either more supply comes back online or prices climb high enough to truly destroy demand. Swing producers like US shale or Saudi Arabia are not particularly interested in drilling more, so it seems like higher oil prices are here to stay until there is some positive news. There’s an OPEC+ meeting on Thursday, although not much is expected.
Euro halted in its tracks
The euro disliked the news as even higher oil prices will burn a bigger hole in the Eurozone’s terms of trade, leave deeper scars on consumers, and fan the flames of inflation. Recent data releases show that the French economy contracted in Q1 while Germany’s inflation rate hit another multi-decade high, adding credence to worries that Europe is entering a period of slow growth coupled with high inflation.
Investors are split on how hard the ECB will swing in July. A quarter-percentage point rate increase is fully priced into money markets and there’s an implied chance of around 35% for a bigger, half-point move. The upcoming inflation stats today could help settle this debate.
Overall, the ECB is more likely to opt for smaller and systematic rate hikes to prevent any panic in bond markets, especially now that asset purchases are stopping too. This presents a downside risk for the euro considering the current market pricing.
Dollar stable, Wall Street returns
There wasn’t much else happening in the FX complex, with most currency pairs trading in relatively narrow ranges. The dollar managed to stand back on its feet, drawing power from rising Treasury yields and capitalizing on the euro’s troubles. In the stock market, the rollercoaster ride is set to continue. Most European indices are trading in the red today while Wall Street futures point to a neutral open. Investors continue to grapple with heightened uncertainty surrounding the economy as fiscal spending gets rolled back and the Fed closes the liquidity gates.
Valuations have compressed substantially but that doesn’t mean the pain is over as the next shoe to drop may be downward revisions to corporate earnings estimates in the face of slowing growth. For the market to find a true bottom, it will likely require some positive fundamental catalyst too - such as the Fed hitting ‘pause’, or China abandoning draconian lockdowns.
As for today, the main event will be a meeting between US President Biden, Fed Chairman Powell, and Treasury Secretary Yellen at 17:15 GMT to discuss inflation. The Fed has been adamant it will raise rates and suppress demand, so the emphasis is now on the government to expand the productive capacity of the economy and help quell inflation in time for November's midterm elections.