Oil Below $110 as U.S. Recession Fear Strikes at Energy Rally

By Barani Krishnan

Investing.com -- Is this the selloff that the cooler heads in the oil market have been talking about?

Crude prices tumbled some 7% on Friday alone, with the weekly loss even larger, at around 9%. The plunge came amid widespread fear that the United States was headed for a recession from the triple whammy of weakening macroeconomic data, inflation unyielding at 40-year highs and a Fed determined to break the back of that with equally risque rate hikes.

“Recessions are increasingly likely as central banks race to dramatically raise rates before inflation spirals out of control,” Craig Erlam, analyst at online trading platform OANDA, said as the European Central Bank indicated three big rate hikes as well for 2022. “It is better than the alternative though; stagflation.” 

While the world, particularly the United States, was not yet in a stagflationary environment, where prices keeps rising while the economy continues falling, the term has “been thrown around way too much in recent months, which perhaps highlights the trepidation around it,” Erlam said.

“The risk of one is rising, which is why central banks are becoming increasingly accepting of their actions tipping the economy into recession,” he added.

The last straw for investors in an overly-bought oil market on Friday appeared to be a fifth monthly drop in U.S. factory output, as firms struggled with supply-chain bottlenecks and high costs, despite industrial production itself gaining.

The Fed’s divisional chief for Minneapolis, Neel Kashkari, meanwhile warned that the central bank might need to get more aggressive with interest rates if US inflation doesn't retreat from four-decade highs. 

That was a sign that June’s three-quarter percentage point increase — the largest in 28 years — could be followed up by more major hikes, despite Fed Chair Jerome Powell’s assurance earlier this week that there will be no more super-sized hikes this year and that rate cuts could actually come as early as 2024.

The U.S. economy has already shown a negative growth of 1.4% for the first quarter. If it does not return to the positive by the second quarter, the United States will technically be in a recession, given that it takes just two straight quarters of negative growth to be in recession. 

Responding to that fear, New York-traded West Texas Intermediate, the benchmark for U.S. crude, settled down $8.03, or 6.8%, at $109.56 per barrel. For the week, WTI was down almost 9%, for its first weekly loss since April.

London-traded Brent crude, the global oil benchmark, settled down $6.69, or 5.6%, at $113.12. For the week, Brent tumbled more than 7% for its first weekly drop as well in two months.

WTI surged earlier this week to a three-month peak of $123.18, its highest since the March run-up to almost $130 right after Russia’s invasion of Ukraine. Brent reached $125.16, after the March peak, which itself was the highest in 14 years.

While the Ukraine invasion and subsequent Western sanctions on major energy exporter Russia had definitely exacerbated the global tightness in crude supplies, this year’s rally in oil was beyond the affordability of many poor, consuming nations, say analysts.

In the United States, the best gauge of public burden from the rally was the pump price of gasoline, or petrol, that exceeded $5 a gallon for the first time since last week. Many pumps in the U.S., especially those in West Coast states like California, were selling at close to $6 a gallon, the American Automobile Association said. Diesel was even higher in California, at beyond $7 a gallon.

“It’s nuts, what the bulls have been doing,” said John Kilduff, partner at New York energy hedge fund Again Capital. 

“I know we have a global deficit in oil but seriously, how much more do you want consumers to pay?” said Kilduff. “There is a limit to the supply tightness hype. I’m pretty sure that we’ll be hearing cries of ‘oversold’ from the other side after this and we could jump a couple of dollars or more after the weekend. But this is a good reminder that there are still some sane heads in the market examining all the macroeconomic data that’s coming in, and reacting accordingly.”

Among that “other side” was Goldman Sachs' chief commodities analyst Jeff Currie, who’s stood out as Wall Street’s chief cheerleader for oil in calling for even higher crude prices before any real demand destruction could set in.

Other oil bulls also remained unperturbed by Friday’s selloff. 

“Unless the economy goes into a total meltdown, those drops in prices should be opportunities to put on long-term bullish positions,” said Phil Flynn, analyst at Chicago’s Price Futures Group, who pointed out that the demand for oil during most recessions had not fallen by more than 2%. 

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