Morning Brief – False signal

False signal

As a barometer of the world economy the price of oil is watched closely. Due to the relatively inelastic demand and supply of oil, at least in the short run, higher oil prices tend to be a signal of a more active global economy. Therefore movement of energy market tickers higher can serve as the metronome of the global economy.  What we see in today’s market is a confusing signal of a rising oil price but one that could be down to idiosyncratic market conditions rather than a shift of gear for worldwide markets. Certainly, the recent performance of commodity currencies attests to the rising price of oil as a false signal.

Artic conditions have descended through northern America with areas as far South as Texas and the Gulf of Mexico experiencing sub-zero conditions. The freeze has not only driven up the demand for energy but also taken sources of energy including refineries and renewables off grid. Energy prices across the United States, particularly in those areas not familiar with such unseasonable weather, have sky rocketed. This sharp price rise has fed through to the global energy market with the price of Brent crude, oil located in the North Sea, still holding onto price gains this morning. This rise in oil and energy prices has had notable effects on currencies whose economies are exposed to the energy market, namely NOK and to some extent GBP. However, given that the price move is not indicative of a healthier global demand and cross-commodity price increase, traditional commodity, high-beta, currencies are not feeling the warmth they usually might amidst rising energy prices.

Identifying any signal from the noise in energy prices created by the rare conditions in the US oil market is challenging. The price move is particularly important as it sits within the broader, more important and systemic reflation trade that has been captivating markets. As the world prepares for what UK PM Boris Johnson has framed to be the last lockdown and return to normality, many market participants are expecting the price of oil and commodities at large to rally. This expectation is fed by the anticipated broader restoration of demand towards pre-pandemic levels and one that Wall Street names including JPMorgan and Goldman Sachs could send the price of oil per barrel close to $100. It is this kind of broader reflation that will benefit the wider commodity market and therefore impact the valuations of currencies in the wider commodity space including CAD, AUD and NZD. As temperatures are expected to give way to more mild conditions next week, we shall see whether today’s idiosyncratic market event is the catalyst to accelerate the pace of the reflation trade.

Discussion and Analysis by Charles Porter

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