There used to be a very pronounced direct relationship between global oil demand and oil prices and consequently an indirect one between the equity markets, which were and still are the trustworthy barometer of the health of the global economy, and oil prices. The supply side of the oil equation, as far as financial investors were concerned, was left to OPEC, the market entrusted the producer group to act as the faithful swing producer and cut when global inventories were bulging or increase when they depleted. This status quo was upended with the emergence of the US shale sector and the growing oil independence of the world’s biggest oil consumer.

Since the second half of October last year the major stock indices have embarked on an upward journey. The MSCI All-country Index has gained 22% and the tech-heavy Nasdaq Composite Index in the US has returned 27% in the last six months. In this period front-month Brent has hardly made any advances and actually deviated from the equity trajectory between October and December confirming the above observation. To put a different spin on this fall-out, at the end of October one unit of the worldwide stock index was worth less than 7 bbls of Brent. Yesterday it fetched 8.7 bbls.

Stocks have become more attractive in the eyes of the investors than oil, probably for two reasons. Stubborn expectations for rate cuts in the developed part of the world fueled the equity market rally together with the seemingly insatiable appetite for stocks in the AI sector. (Chipmaker Nvidia is now worth nearly twice as much as at the end of October and Microsoft has matched the performance of the Nasdaq index.) This optimism has been embedded in global oil demand estimates. Whilst absolute figures diverge significantly there is a consensus between forecasters that consumption will grow meaningfully both this year and next. The somewhat tepid performance of oil compared to equities has been the function of resilient non-OPEC supply and a comfortable spare capacity from the OPEC alliance that can be relied upon in case of supply emergency. The latter is the reason why geopolitical/geoeconomic risk premium remains subdued, notwithstanding the ongoing Russian attacks on its western neighbour, Ukraine’s successful assaults on the invader’s oil installations and the perpetual antagonism between Israel and Hamas and its allies.

The presently sanguine mood amongst equity investors, however, might start souring soon. The lowering of the borrowing costs might not materialize as early and hastily as anticipated. In fact, it is akin to peak oil demand in that it is always expected but never arrives. The trouble is the resilient economy. If it does well, consumer prices remain elevated and cheapening the price of money will only re-ignite inflationary pressure. And disinflation is a notoriously cumbersome task to tackle – as mirrored in the latest set of US data. Of course, one might argue that even if the Federal Reserve decides to kick the can of the first rate cut down the road other central banks are free to ignore it, economic data allowing. Such moves from the European Central Bank or from the Bank of England, alas, would strengthen the greenback putting renewed pressure on the economies in general and consumer spending in particular. In interconnected economies co-operation of central banks, tacit or otherwise, is necessary and advisable.

Economies can and do diverge, yet the major central banks have moved in harmony, albeit with a brief time lag, in the past two years to increase borrowing costs and the same will plausibly happen when the time is ripe to lower them. As pointed out in the Financial Times, the market expectations are for one, maybe two rate cuts from the Fed and the BoE this year, whilst the ECB could act three times. These downward sloping interest rate curves for the rest of the incumbent year are much less steep than even a few months ago. In other words, life will remain more expensive than hoped for, and economic growth forecasts will need to be scaled back. Stock markets might peak in the very near future or they might have already done so last months. Tenaciously high rates could appreciate the attractiveness of safe havens, including the dollar and the inverse correlation between the world’s reserve currency and equities might be re-established soon. It will also pressure oil re-enforcing our view that fresh annual peaks are implausible. The retreat in stocks might, however, be faster and the yawning gap between equities and oil could narrow. Sticky inflation and delays in predestined rate cuts simply do not bode well for risk assets.

Thawing of Middle East Tension

One could almost hear the humming of computers throughout yesterday that run algorithms searching the worldwide web for expressions such as Middle East, tension, ceasefire, truce. In a rare and welcome change of sentiment the Israeli stance has somewhat softened and an initial hostage deal lasting for six weeks and serving as a precursor for the second phase of ‘sustainable calm’ has gotten ever closer. Whatever the outcome of the latest round of talks will be, it will unlikely have a palpable impact on oil prices, we must remind ourselves, since output in the region has not been adversely affected over the course of the conflict. Yet the gut reaction sent oil prices a dollar lower and the weakness spills over into this morning because the Chinese factory and non-manufacturing sectors both expanded in April slower than previously.

Heightened anxiety about inflation and interest rates, on the other hand and as discussed above, can materially influence investors’ mood and every single word of the Fed chairman will be scrutinized tomorrow after the rate decision in search for clues how and when the US borrowing cost could change (change is the key word here as even raising it must not be fully ruled out), and consequently how bond yields and the dollar exchange year might be affected. Finally, one must not dismiss the impact of the disturbing and prolonged stand-off between Russia and Ukraine as attacks on Russian oil infrastructures have resumed and idle primary refining capacity in the country increased by nearly 14% in April from the previous month, Reuters calculates. It is a volatile start of the week in what will prove to be a data-heavy 5 days where our market will probably be predominantly influenced by macroeconomic considerations whilst violating either boundary of the present $10/bbl range seems a tall order.

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