For a year now investors had been positioning themselves for the time when the Federal Reserve decides to lower the cost of borrowing after keeping at ay 5.5% since July 2023. The move, the thinking went, would signal that inflation had been reined in and soft landing had been achieved. It would couple with the easing of job market conditions as it was the relentless rise of wages growth that predominantly kept inflationary pressure elevated. The ECB had already cut rates in June, the BoE followed suit last week and there was a growing conviction that the Fed will do the same in September.

It is increasingly plausible that it will actually be the case, however the interpretation of it is in stark contrast with what was anticipated only a few weeks ago. The culprit is the labour market. Friday’s nonfarm payroll data showed an increase of a mere 114,000 jobs in July, significantly below the predicted 175,000 number and well under the 200,000 level needed, economists say, to keep up with population growth. Unemployment escalated to 4.3%, the highest in almost three years. 

The view on soft landing was hastily amended to one that envisages impending recession forcing the US central bank to cut interest rate in September by more than expected and maybe even reduce borrowing costs further come December. The S&P 500 index lost 2% week-on-week and so did the MSCI All-Country Index. Bond yields plummeted with the 10-year yield plunging from 4.2% to 3.8% in the space of one week. Potential economic turmoil sent the dollar sharply lower, its index settled under 103 on Friday.

There were two more factors that played a significant role in last week’s turmoil and helped deserting risk assets. The first one was growing concerns that the tech bubble has burst or about to do so. The tech sector has been a sturdy supporter of the US equity markets in recent months, yet Intel lost one-quarter of its value after announcing a 15% cut to its workforce and hedge fund Elliot Management admonished clients that the technology, artificial intelligence that is, that has been the major contributor to the stellar performance of Nvidia, is ‘overhyped’. The Nasdaq Composite Index outperformed its peers on the downside settling 3.35% lower. The third ingredient behind last week’s rout was the Bank of Japan surprise decision to increase interest rates, which narrowed the gap between US and Japanese rates strengthening the yen, a blatantly ominous sign over the prospects of Japanese exporters are facing. The country’s main stock index was pushed over the precipice on Friday when it shed 5.8% of its value and dumping a further 8.5% this morning.

Since economic turbulence was the major driving force behind the bleak outlook last week oil could not defy the gravity that impacted financial markets so horrendously. Fears of demand destruction are on the ascent and whilst Middle East geopolitics could provide sporadic support, especially after the recent assassination of a prominent Hamas leader on Iranian sole and the perceived retaliation from Iran. China’s difficulties of stimulating consumers to spend has been well publicized but in case demand concerns receive a global angle the current views on anticipated stock depletion in the third and fourth quarters might have to be re-evaluated or dismissed. And the question is whether OPEC+ has the power to do anything meaningful on balancing the market.

Compensation and Unwinding

Members with voluntary output cuts tentatively agreed to gradually roll back these constraints amounting to 2.2 mbpd starting October this year throughout September 2025. Almost at the same time major overproducers of the group, Iraq, Kazakhstan, and Russia pledged to make amends to their lax compliance and compensate starting last month. Judging by the price action the unwinding of unilateral cuts might be postponed. It is worth exploring how the oil balance would be impacted under this scenario also assuming that the laggards mentioned above will stick to their promises and cut output.

It is impossible not to notice that the proposed unwinding of voluntary cuts and the compensation for overproduction roughly even out in the last quarter of the year. Under the submitted compensation plan the three countries would collectively and in a staggered way take off 152,000 bpd off the market with Russia only cutting 10,000 and 300,000 bpd in October and November and gradually increasing these restraints in 2025. At the beginning of June, the 8 producing nations that decided to reduce their output by 2.2 mbpd in November 2023 pledged to gradually re-add these barrels between October 2024 and September 2025 but ‘this monthly increase can be paused or reversed subject to market conditions.’

After last week’s disastrous sell-off it is sensible to arrive at the conclusion that the phase-out of the voluntary cuts will, in fact be reversed. Assuming that the three overproducers will adhere to their pledges and will reduce output by 152,000 bpd the oil balance will get tighter. Will it lead to meaningful stock depletion?

The answer is yes. It will be curious to see whether oil demand estimates are downgraded when the updated reports come out in the middle of the month. If they are the world will not need as much DoC oil as previously thought but suppose it will be left unchanged. The latest IEA estimate puts it at 41.7 mbpd for 4Q and OPEC at 43.9 mbpd - a huge cleavage. OPEC+ are allowed to pump 33.909 mbpd and adding the latest output figures from the four countries with no restrictions (Iran, Libya, Mexico and Venezuela) we arrive at 40.744 mbpd. Take away the 152,000 bpd compensation pledge and you’ll find that global stocks will decline sharply in the last quarter of the year – even if you base your calculation on the IEA number.

This thought process presents us with an awfully bullish oil balance, inconsistent with and contradictory to the price action – even before last week’s souring of mood, the struggle to challenge $90/bbl was conspicuous. This leads us to believe that OPEC+ plans to add or withdraw oil from the market and oil balance projections with all their ambiguity just simply do not serve as a reliable gauge of future price movements. Oil is seemingly being driven by macroeconomic considerations and apart from the ad hoc geopolitical support a renewed rally, whenever it comes, in the equity markets will be the harbinger of oil’s changing fortune.

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