The view that the US Central Bank will announce some sort of a stimulus program at the end of the FOMC meeting today did more for the markets than the outcome of the Greek election...global equity markets rallied while most commodity markets held steady. The outcome of the FOMC meeting will be announced at 12:30 PM EST with a presser by Chairman Bernanke at 2:15 PM. The market has been pricing in some form of a new stimulus program whether it be an extension of operation Twist or a full blow QE3 program. I am still expecting either a wait and see (for more data points) strategy or a temporary extension of Operation Twist rather than a brand new QE something program. If my projection is the outcome I would expect the market to be disappointed and likely result in selling hitting most of the risk asset markets...at least as an immediate reaction. The Fed is going to have to announce a brand new QE program for risk asset markets to rally above current levels. An extension of Twist is not likely to result in much of an additional rally.
Irrespective of the outcome the reason the market is putting so much emphasis on the outcome of one Fed FOMC meeting is because the US economy is going nowhere quick. The underlying problem is a slowing US economy which is slowing from a low growth rate to start with and as such if the slowing continues it certainly exposes the US to a drift back into a recession. This coupled with the financial mess in Europe...which is almost certain to head back into recession at some point in time this year...along with a slowing of the main economic growth engine of the world ...China... does not bode well for any of these economies to jump start on their own. Whether or not the Fed acts today Central Bankers around the world have either already committed to some form of easing...China lowering interest rates, UK more QE while others are likely to join the money printing business sometime in the foreseeable future.
Although none of these actions will fix the underlying problems they will certainly minimize the downside risk in most risk asset markets in the medium term. These actions will also buy time for the global economy to try to turn itself around...especially in a major election year for the US. I hope that no new stimulus is added to the US economy as it just kicks the debt can down the road and exposes the economy to a round of inflation which I believe is worse than a slow growing economy. We will know more in a few hours and the outcome will be the main market mover today.
As I projected the Iran and P5+1 round of meetings in Moscow ended with no progress. The comments indicated that the meetings were intense and pointed but both sides still seem to be far apart. There is a technical meeting scheduled for July 3rd in Istanbul with a negotiating meeting not yet scheduled. I expect the meetings to continue as I do not think the US or Europe have the desire to get involved militarily at this point in time as both the US and EU economies are faltering with many problems yet to solve. A military event will result in a surge in oil prices and a big distraction to solving he economic problems at home. As such negotiations will continue while the sanctions slowly continue to impact Iran. The EU crude oil purchase embargo seems likely to go forward as of July 1st which should result in a reduction of Iranian exports of upwards of a 1 million bpd (as per the IEA in their last Oil Market report). With the global economy just inching along and the Saudi's producing at a high level I do not anticipate any supply issues in the medium term.
Global equities rallied the most ahead of the announcement of the FOMC meeting as shown in the EMI Global Equity Index table below. The Index gained a little over 1% over the last twenty four hours widening the year to date gain to 2.2%. Eight of the ten bourses are now in positive territory for the year. Germany remains at the top of the leader board with the Paris CAC 40 holding the bottom spot. For the moment global equities remain a positive price driver for oil and the boarder commodity complex.
The API report showed a surprise draw in crude oil versus an expectation for a build and a surprise draw in distillate stocks along with a build in gasoline inventories within the expectations. The API reported a draw (of about 0.6 million barrels) in crude oil stocks and outside the expectation range as crude oil imports decreased while refinery run rates increased by 2.4%. The API reported a modest build in gasoline stocks. They also reported a surprise draw in distillate stocks versus an expectation for a more seasonal build in distillate fuel inventories.
The report is bullish for distillate, neutral for crude oil and bearish for gasoline. The market has not reacted strongly in overnight trading but has been stabilizing for all commodities in the complex ahead of the FOMC meeting announcement 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 0.6 million barrels of crude oil with a build of 1.7 million barrels in PADD 2 and a build of 0.625 million barrels in Cushing, Ok which is bullish for the Brent/WTI spread. On the week gasoline stocks increased by about 1.1 million barrels while distillate fuel stocks decreased by about 0.3 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. The tensions evolving in the Middle East between Iran and the West have been easing as another meeting is currently underway. 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 off momentum 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 reports are summarized in the following table. I am expecting the industry to continue its aggressive 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 draw in crude oil inventories and a build in both gasoline and distillate fuel stocks as the summer planting season is over (decreasing the demand for diesel fuel) while heating oil demand is also over. I am expecting crude oil stocks to decrease by about 1.0 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 19.6 million barrels while the overhang versus the five year average for the same week will widen to around 36.7 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 starting to increase 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 $12/bbl premium to Brent level for the last few days. 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 0.2% I am expecting modest build in gasoline stocks. Gasoline stocks are expected to increase by 1.0 million barrels which would result in the gasoline year over year deficit coming in around 11.8 million barrels while the deficit versus the five year average for the same week will come in around 7.8 million barrels.
Distillate fuel is projected to increase by 1.0 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 21 million barrels below last year while the deficit versus the five year average will come in around 17.6 million barrels.
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 were 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 am still maintaining my oil view at neutral. I am still expecting the oil complex to remain the $80 to $90/bbl trading range basis WTI and $95 to $105/bbl basis Brent barring any surprises from the many June events. The outcome of all of the upcoming events I have been discussing in the newsletter over the last several weeks will determine whether or not oil prices move outside of the boundaries of the trading ranges.
I am keeping my view at neutral to see if Nat Gas is able to hold onto the developing trading range. The surplus is still narrowing in inventory versus both last year and the five year average but could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.
Currently markets are mixed as shown in the following table.
Dominick A. Chirichella
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