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Chinese stimulus is driving oil higher but the Fed’s guidance will be key

Intermediate

Oil has been moving higher since the end of June. After a bout of consolidation over the past week the price has broken higher once more (arguably a “bull flag” on the technicals). The latest driving force has been the talk of stimulus from the Chinese Government. However, this short-term bump higher could quickly turn sour again if the Federal Reserve remains hawkish on Wednesday.

  • Tighter supply whilst Chinese support for the property sector boosts demand prospects
  • The assessment of a less hawkish Fed has driven oil higher, but the FOMC decision will be pivotal

Oil futures break higher, now eyeing key medium-term resistance above $80

China and Oil

Tighter oil supply whilst China pledges support

Oil supplies remain restricted. The output cuts from Saudi Arabia have been helping to support the oil price in recent weeks. Saudi pledged to cut output by around -1 million barrels per day (around -10% of its total) into August. Russia also agreed to cut oil exports by 500,000 barrels per day in August. This followed the OPEC+ meeting in June where members agreed to extend its production cuts into 2024.

This has been helping to drive the oil price higher in recent weeks (along with the prospects of a less hawkish Fed). However, there was another boost yesterday, with reports out of China that top policymakers would step up policy support for the economy. With the global economy still ailing from the aggressive tight monetary policy of major central banks, Chinese economic data have been showing a spluttering economic re-opening from zero-COVID. Demand both at home and abroad has been failing. Last week’s Q2 GDP of just +0.8% QoQ gave a significant reflection of this. Seemingly we are about to get the response.

For several weeks, market chatter has been about when and how the Chinese authorities would respond. Although there has been nothing specific announced so far, the Politburo (the decision-making body of the Chinese Communist Party) has indicated that there will be some economic policy adjustments that focus on expanding domestic demand, boosting confidence and preventing risks. China will implement macro adjustments “in a precise and forceful manner”.

According to Xinhua, measures will include boosting domestic demand through increasing income. Also spurring investment by speeding up local special bond issuance has been suggested. Furthermore, helping to support the ailing housing market by easing home purchase restrictions could be seen.

Chinese stimulus helps to support oil demand

Markets have taken these pledges and added them up to mean an improvement in oil demand. China has been expected to make up as much as two-thirds of global oil demand growth this year. This has boosted the oil price.

However, it is important to note that China has not announced anything formal yet. This could mean that they do not see it as an urgent issue, or just that they are undecided on the correct path to take. Until the detail is confirmed, this near-term move may be short-lived.

The message from the Fed meeting will be key

Furthermore, there is another event on the immediate horizon that could scupper the bull move in oil. The Fed meeting announcement is on Wednesday. A resumption of tightening is all but guaranteed, with a 25 basis points hike expected. However, the message that goes with it will be key for risk assets such as oil.

Oil traders have been re-positioning over recent weeks. The view is that the Fed could ultimately be less hawkish than it has led us to believe. Falling inflation in the CPI and the PPI has positioned the market to price for just one more hike this year before cuts start to come through in Q2 2024.

However, if the Fed sticks to its guns and signals that it will continue to expect one final rate hike after July, then markets will need to respond. This would drive Treasury yields back higher, strengthen the USD and drive flow out of riskier assets such as oil. The rally in oil futures would then likely retreat once more.

Technicals are bullish, for now

Looking at the chart of NYMEX Oil futures, the technical analysis is more positive than it has been for over three months. The break above $75.06 was key a couple of weeks ago and now opens a move towards key multi-month highs. A higher low at $73.84 has also strengthened the support of what is now a pivot band in the middle of a $20 long-term range between $63.65/$83.53.

With the Relative Strength Index momentum holding consistently above 50, the momentum is increasingly positive and suggests that weakness is a chance to buy. The move above the 200-day moving average is also seen as an important signal of a change to a more positive outlook.

oil futures

The breakout above $77.33 yesterday means that the next important resistance is not until the multi-month barrier of the highs between $82.65/$83.53. A sharp uptrend is running the price higher (just above $76 today), with the breakout at $77.33 initially supportive too. However, if there is a hawkish lean from the Fed, traders will need to be alert to another change of direction. They would likely need to be casting an eye further down towards the key higher low at $73.84. A break under there would change the outlook negatively once more. 

Editor

Richard is an independent market analyst with over 20 years of experience working for brokers in London. Most recently he has worked with Hantec Markets and Infinox, focusing on trading education, ana... Continued

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