Today at 2:15 PM EST the first shot over the bow will hit as the US FOMC meeting outcome is announced. The easy one... short term interest rates will remain low for an extended period of time. The more difficult one to call... no QE3 at this point in time but the Fed will reiterate all tools are available and elaborate on forward guidance. They are likely to go on to say that they may have to consider additional steps if the loss of momentum in the economy continues. They already extended Operation Twist at the June meeting and they may possibly lower the interest rate the Fed pays on bank reserves from 0.25% to bring down the short term borrowing cost. If the outcome is as presented the markets will likely be disappointing as many are assuming that QE3 will be the outcome.

I am not sure the disappointment will result in a strong round of selling as there is still the ECB meeting tomorrow. Also there is what I consider the long shot outcome today and that is the Fed simply embarks on QE3 and does not wait for any further signs that the US economy is faltering. The markets should remain relatively quiet and stable until the outcome is announced. As I said yesterday the main price driver for all risk asset markets will be today's FOMC announcement followed by tomorrow's ECB outcome. Everything else is a secondary price driver in the short term.

In spite of all of the uncertainty and volatility July turned out to be a positive month for the bulls. For the first time in two years most commodities, equities, bonds and the US dollar gained ground across the month. So far this has been an interesting investing/trading year with most risk asset markets gaining ground during the first seven months of the year with the exception of some of the oils. With the first seven months of the year now in the history books the clear winner in the commodities category continues to be the grains and in particular Soybeans which are all surging as a strong heat wave envelops the mid-section of the US or the heart of the agricultural center resulting in one of the most severe droughts in many years. As shown in the EMI Investment Leader Board below WTI was the biggest loser on the board with the Nymex RBOB gasoline contract showing the only gain in the oil complex after the first seven months of 2012. Nat Gas has made a strong recovery over the last month and is now in positive territory for the year to date. Metals were marginally higher with Gold the leader in this commodity sector while equities were higher in most places around the world but with uneven gains depending on location and the sector of the economy.
Global equities gave back most of their earlier week gains over the last 24 hours as shown in the EMI Global Equity Index table below. The Index is now up by only 0.1% for the week with the year to date gain at 2%. The markets are simply in a wait and see mode insofar as the outcome of the today's FOMC meeting as well as tomorrow's ECB meeting. For today the market is looking for any signs of a new round of quantitative easing as discussed above while market participants are anxiously awaiting more clarity on what Mr. Draghi meant by "everything" when referring to the ECB support of the euro. For today equities are not a leading price driver rather they will be reactionary based on the central bank outcomes.
The oil complex is back into positive territory in overnight trading after a bullish API oil inventory report (see below for more details) but tempered by yet another bearish data point out of the main oil demand growth engine of the world...China. The National Bureau of Statistics and the China Federation of Logistics and Purchasing reported the July PMI index dropped to 50.1 or the lowest level in eight months. The PMI came in below expectations and is barely above the expansion threshold level. This is not only a bearish number for the Chinese economy but since it is an energy sensitive indicator and especially negative for oil demand growth.

The API report showed a surprisingly huge draw in crude oil stocks as well as unexpected declines in both gasoline and distillate fuel stocks. The API reported a draw (of about 11.6 million barrels) in crude oil stocks versus an expectation for a small build as crude oil imports decreased and even as refinery run rates decreased modestly by 0.9%. The API reported a strong draw in distillate stocks. They also reported a modest draw in gasoline stocks versus an expectation for a smaller build in gasoline inventories.
The report is bullish across the board. The market has not reacted much in overnight trading with prices modestly higher ahead of the EIA oil inventory report at 10:30 AM today. The market is always cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning at 10:30 AM. The API reported a draw of about 11.6 million barrels of crude oil with a draw of 1.4 million barrels in Cushing, Ok and a 2.9 million barrel draw in PADD 2 which is bearish for the Brent/WTI spread. On the week gasoline stocks decreased by about 1.3 million barrels while distillate fuel stocks decreased by about 1.4 million barrels.

At the moment oil prices are still being mostly driven by the events discussed above along with the direction of the euro and the US dollar as well as by a view that the global economy is continuing to slow and one or two of the major central banks will come to the rescue. The tensions evolving in the Middle East between Iran and the West seem to be in the background for today. As such we may not see much of a reaction from market participants to this week's round of oil inventory data as the macro risk of the markets is currently the main concern of all market players. This week's oil inventory report will likely be a background price catalyst unless the actual outcome is significantly different from the market projections.

My projections for this week's inventory report are summarized in the following table. I am expecting the US refining sector to continue its campaign of converting a portion of the surplus crude that has been building for the last several months into refined products... in particular gasoline and distillate fuels whose inventories have been in decline. I am expecting a small build in crude oil inventories and a build in both gasoline and distillate fuel stocks as the heart of the summer driving season is now in full play. I am expecting crude oil stocks to increase by about 0.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 26.6 million barrels while the overhang versus the five year average for the same week will come in around 40.1 million barrels.

I am also expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is now pumping and refinery run rates are continuing at high levels in that region of the US. This would be bearish for the Brent/WTI spread in the short term which is now trading around the $16/bbl premium to Brent level. I am still of the view that the spread will continue the process of normalization over the next 3 to 6 months.

With refinery runs expected to increase by 0.1% I am expecting a small build in gasoline stocks. Gasoline stocks are expected to increase by 0.2 million barrels which would result in the gasoline year over year deficit coming in around 3.3 million barrels while the deficit versus the five year average for the same week will come in around 3.2 million barrels.
Distillate fuel is projected to increase by 1 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 25.6 million barrels below last year while the deficit versus the five year average will come in around 21.6 million barrels. Exports of distillate fuel have been the main storyline this year with exports running around 1 million bpd.

The following table compares my projections for this week's report (for the categories I am making projections) with the change in inventories for the same period last year. As you can see from the table last year's inventories are mostly in the same direction as the projections. As such if the actual data is in line with the projections there will only be a modest change in the year over year comparisons for most of the complex.
I still think the oil price is overvalued however with the potential for bold action by one or both of the central banks I am maintaining my view at cautiously bullish for oil as the market has moved to being mostly driven by the prospects for additional quantitative easing over concerns with the evolving debt situation in Europe as well as the slowing of the global economy. I want to emphasize the word cautious in my view. WTI is currently in a $85 to $95/bbl trading range while Brent is still in the $100 to $110 trading range. There are a lot of dynamics that will impact oil prices in the short term and the ranking of the price drivers are fluid and very susceptible to changing as we saw after Draghi's comments yesterday. The only constant for oil prices in the short term is above normal levels of volatility.
I am maintaining my Nat Gas view at cautiously bullish with a lot of emphasis on cautious as the hot weather has persisted across major portion of the US and is forecast to continue for at least another several weeks. Even though the economics of coal switching continues to be favorable to coal... which will result in a reduction in Nat Gas demand the above normal cooling demand and nuke outages should keep injections underperforming.

Currently markets ended the week mostly higher as shown in the following table.

Best regards,
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.