The stronger and longer the trend, the bigger the temptation to realize profit. Almost any excuse will do. It does not even have to be an actual development; a rumor or gossip will be sufficient to shepherd the herd towards the exit. It was always expected and even obvious that the latest leg north, which started in the second half of August, would come to an end, whether temporary or permanent. What was not clear is when and what will be the trigger. The answer was provided by the central banks of several developed nations last week. In the run up to their meetings where the fate of interest rates was discussed oil started to drift lower. This move then intensified after the Fed made its decision and continued Thursday morning as several other central banks followed suit and announced their preferred way of action in the fight of mitigating inflation.

When a trend is abruptly halted it is never entirely clear whether it is just a correction or a reversal. Lack of encouragement often makes market players cautious and pragmatic and re-establishing the original move could be a cumbersome undertaking. Not last week. As oil prices were making new weekly lows Russia announced a temporary ban on product exports in order to ensure smooth domestic supply. Once again, the mood and the price direction changed suddenly. Given that Russia remains a salient supplier of middle distillates, even despite the G7 price cap that came into effect in February, the move sent shockwaves throughout the market, the major beneficiaries of which were ICE Gasoil and CME Heating Oil – after all, the country’s diesel exports averaged 800,00 bpd in the first eight months of the year, Energy Intelligence estimates. How long the ban will last, what volume will exactly be affected, whether there is a sinister motive behind the ban are all unclear. What is apparent is that it comes just before winter and at a time when Russian crude oil exports are constrained as part of the agreement with Saudi Arabia to limit production and exports by a collective 1.3 mbpd until the end of the year. The supply deficit and stock depletion penciled in for the fourth quarter of the year has just gotten more critical and potential distillate shortage has become aggravated.

Yet, the initial reaction was not followed through. Prices retreated from Thursday’s summits. After Friday’s perplexing and irrational trading session WTI finished the week unchanged but the rest lost values, products much more than Brent. The last day of the week saw the backwardation significantly widening on the crude oil contracts but the structure of products, together with outright prices, have tumbled considerably. It was a confounding end to what seemed to have turned out to be a frighteningly bullish week.  Does the lukewarm performance imply a nonchalant attitude towards the Russian export ban and are fears of tightness unsubstantiated? Well, the answer is no, but investors clearly have other factors to consider, too.

Hawks are Circling

The latest round of central bank action started the week before last when the ECB decided to raise rates to 4.0%, the 10th successive hike and the highest since the common currency was launched. The Fed then left the deposit rates steady, so did the Swiss National Bank, the BoE and the BoJ. The Swedish and Norwegian central banks opted for an increase of 25 basis points. The latter envisages another hike in December. Nonetheless, the general feeling is that peak rates are close, there is no need to tighten the belt further in most cases. The latest data from Europe and the UK confirms it – the manufacturing and service sectors are still in contraction. The monetary tightening has seemingly been effective, economies are cooling, recession should be narrowly avoided, and it is time now to pop the cork, right?

Not quite. The potential halt in upping borrowing costs is, indeed, a welcome achievement, and central banks must take plaudits for it. Rate decisions undeniably shape the economy, however, these days they pale into insignificance when compared to the press conferences of bank chiefs. Their speeches are scrutinized down to the last word as investors are desperate to learn what the future might hold. In the absence of the good old-fashioned forward guidance the picture is ambivalent. The potentates of monetary policy acknowledge that the path laid down to defeat inflation leads to the right direction, but they are at pains to warn against complacency, in part due to rising energy prices. To translate it into the language of financial markets rates will plausibly stay high throughout 2024.

‘We will need to keep interest rates high enough for long enough to get the job done’ – Andrew Baily, Bank of England.

‘It’s a good thing that the economy is strong … The only concern is it just means that if the economy comes in stronger than expected, that just means we will have to do more in terms of monetary policy to get back to 2%’ - Jerome Powell, Federal Reserve.

‘The difficult times are now and the recovery that we anticipated is pushed out into 2024 … We are not saying we are now at peak’ – Christine Lagarde.

Rate cuts are ostensibly not imminent. Interest rates are to remain elevated for longer than previously anticipated. This is also what the OECD encourages central banks to do. In their view to ease monetary policy without registering ‘durable progress in defeating inflation’ is a perilous exercise. If benchmark rates stay high next year, mortgage rates will remain, well, inflated, consumer confident and spending will come under pressure, companies will feel disincentivized to expand since borrowing is expensive. The economies of developed nations are flying into headwinds. Within the developing world, Chinese troubles are well-publicized. There is a debt crisis developing in several other nations because the strong dollar makes it impossible to service these debts. One can only wonder how the oil market will react if or when the support from major oil producers is withdrawn. It should prove resilient thanks to OPEC+ in the foreseeable future. But further down the line?
 

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