Crude oil prices initially slumped yesterday as the People's Bank of China (PBOC) raised interest rates for the second time in 6 weeks. WTI crude then recovered mildly while Brent crude rebounded strongly later in the day as the unrest in Egypt escalated again. The front-month contract for WTI crude oil price plunged to as low as 86.88 before closing at 86.94, down -0.62%. The benchmark contract for Brent crude reversed the losses and ended the day gaining +0.68%. Gold price jumped on safe-haven demand as protests in Egypt continued and on inflation- hedge demand as China's rate hike reignited concerns of overheating in the country. Benchmark Comex futures climbed to a 3-week high of 1368.7 before settling at 1364.1, up +1.18%.

The PBoC raised China's benchmark lending rates by +25 bps to 6.06%. This was the third hike since mid-October and the second rate hike in 6 weeks. This move signaled the government's commitment to curb inflationary pressures but also reignited concerns over overheating. The market currently expects inflation to have accelerated to 5.3% in January after easing to 4.6% in the prior month. We believe the government will need to tighten further in coming month so as to effectively curb inflation and prickle asset bubbles. Indeed, while the deposit rate stands at 3% after the rate hike, it's almost 2% lower than the annual inflation rate, suggesting negative return on savings. This policy should not be able to encourage saving and control the flow of money to investments.

Concerning monetary measures, Fed presidents' views are divergent. Richmond Fed President Lacker, not a voting member, said the central bank should consider unwinding QE2 - the 600B asset-buying program announced last November. He said the 'distinct improvement in the economic outlook since the program was initiated suggests taking revaluation quite seriously'. However, Lacker is still not ready to stop the program right now, while 'strong readings on jobs and sustained consumer spending would warrant a rethink on growth'. Lacker's view is obviously in contrast with another non-voter Atlanta Fed President
Lockhart whose view is more in line with Chairman Bernanke that 'underlying inflation is currently below the level' that would be defined as price stability'. The focus today will be on Fed Chairman Bernanke who will testify in front of the House Budget Committee.

The industry-sponsored API reported crude oil inventory drew -0.558 mmb in the week ended February 4. Distillate inventory also fell but the drop was below market expectations. Gasoline inventory, however, rose +3.2 mmb during the week. The official report from the DOE/EIA probably shows increases in both crude and gasoline inventories while a draw in distillate stockpile.

Weekly change in inventory as of 04/02/10 ChangeConsensusPrevious
Crude oil  +2.40 mmb+2.59 mmb
Gasoline  +2.50 mmb+6.15 mmb
Distillate  -1.20 mmb-1.58 mmb

Comparison between API and EIA reports:

API (Jan 28) EIA (Jan 28)
ActualInventoryPreviousForecast (using API's inventory level)Inventory
Crude oil-0.56 mmb346.00 mmb+3.77 mmb

+2.82 mmb

346 mmb
Gasoline+3.20 mmb239.72 mmb+3.91 mmb+3.49 mmb240 mmb
Distillate-0.54 mmb160.74 mmb-1.10 mmb-3.34 mmb161 mmb

API collects stockpile information on a voluntary basis from operators of refineries, 76% of the time, using data in the past 4 years.

Source: Bloomberg, API, EIA

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