When a market sells off on good news, listen to what it could be telling you.
Earlier in the week, we learned that OPEC+ increased its supply quota by a paltry 100,000 million barrels per day. This was a much smaller production target increase than analysts expected and one of the smallest in the history of the cartel.
The oil market rightfully rallied on the news but couldn't hold the gains into the close. Some referred to it as symbolic and others viewed it as a political slap in the face to the United States. However, I believe there is another explanation: OPEC is recognizing global demand destruction.
Although they won't declare it publicly, we all know that cartels, and specifically OPEC+, strive to keep prices elevated to maximize profits for members but not so much as to hinder business relationships. Perhaps, OPEC+ doesn't believe the global economy can support $100ish crude oil prices, particularly while central banks around the world are dramatically increasing interest rates.
Despite Friday's blockbuster payroll report in the U.S., there are signs that confidence is low and consumers are cutting back. Anybody that has attempted to travel lately knows it just isn't as fun as it was prior to March 2020. Prices are high, delays are long, and chaos is standard. Further, economies around the globe appear to, on average, be in worse shape than the U.S. If so, this too will work against the price of oil.
For those focused on the supply side of the equation, the majority of the 2022 oil rally was a reaction to government-mandated sanctions against Russian oil, not the invasion itself. However, by all accounts, most of that supply has managed to circumvent sanctions and make it to market. In short, the sanctions seem to have merely shifted buying and selling partners but didn't decrease the total supply as much as the market assumed.
Additionally, rumors of a rekindling of the Iran Nuclear Deal, which will bring a good amount of supply to the market, are making the rounds again, and, domestically, we are seeing U.S. rig counts start to pick up steam; last week U.S. shale producers added nine rigs!
For the aforementioned reasons, we believe the path of least resistance in oil will be lower overall. But in the short run, we are approaching a price point in which buyers might start looking for bargains and fundamental traders might be looking to go long under the premise the Iran deal will falter (again) and the minuscule OPEC production increase will continue to drive the supply narrative.
Chart Source: QST
From a charting standpoint, oil has fallen back into the pre-war trading pattern. We don't expect the oil market to suddenly make it easy on traders, so we anticipate some severe volatility as traders determine if this is a valid breakdown or a bear trap. That said, even if we see some near-term bouncing action, the break below $90.00 opens the door for an eventual move toward $60.00 per barrel.
For now, however, we suspect buyers will step in somewhere near $85.00, but we can't rule out a probing low to $80.00 and a bear market bounce in oil can be good for $10.00 to $12.00 (the high-$90s).
Whether you are a bull or a bear, you shouldn't marry your position; it will be a bumpy ride.
Chart Source: QST
On a side note, lower highs and lower lows in oil will take some pressure off the headline inflation numbers. In time, this will encourage investors to allocate funds to Treasuries.
Oil has completely unwound the invasion trade, but the 10-Year Note has not. Despite Friday's selling pressure, and the potential of additional correction, we believe Notes will make a round trip similar to the oil market in which late-February pricing is recovered. This would mean a 10-Year Note futures price of 125'0 to 126'0 and a yield of 2% or lower.