strike action

Broader market concerns have weighed on the complex, whilst a stronger dollar has only provided further headwinds. However, for oil at least, the fundamentals remain constructive Energy: Large US crude draws The oil market continues to come under pressure, with Brent falling 1.7% yesterday, following a raft of weaker-than-expected Chinese macro data this week. The latest Fed minutes will not be helping sentiment, with them suggesting that the US Fed may have some more work to do when it comes to monetary tightening. The strength in the USD over much of the week will also be providing further headwinds to the market. As for WTI, it settled below US$80/bbl for the first time since early August. However, whilst there are broader market concerns, oil fundamentals remain largely constructive as continued OPEC+ supply cuts should ensure that we see sizeable inventory draws for the remainder of the year. The EIA’s weekly inventory report was largely constructive, showing that US commercial crude oil inventories fell by 5.96MMbbls over the last week. This leaves crude oil inventories at a little under 440MMbbls, which is the lowest level since the start of the year. Crude oil inventories at Cushing fell by 837Mbbls, leaving them at 33.8MMbbls- levels last seen back in April. The large draw in commercial inventories was largely driven by a rebound in crude oil exports, increasing 2.24MMbbls/d WoW. Refiners also increased their run rates by 0.9pp over the week to 94.7%. Although despite stronger refinery activity, gasoline inventories still fell by 262Mbbls, whilst distillate stocks grew by 296Mbbls. Labour talks in Australia look as though they will roll into next week in an attempt to avoid strike action at several LNG facilities after there was no breakthrough in negotiations earlier this week. Reports suggest that talks will continue next Wednesday. The fact that talks are expected to continue next week has provided some comfort to the market, with TTF settling 2.65% lower yesterday. For Europe, given the comfortable storage situation (90% full), we would need to see a large amount of the roughly 41mtpa LNG capacity at risk, disrupted for a prolonged period, in order to be overly bullish for prices.

Oil prices have strengthened over the summer as fundamentals tighten, whilst natural gas prices have been volatile, with potential strike action in Australia leading to LNG supply uncertainty. Chinese concerns are weighing on metals, but grain markets appear more relaxed despite the collapse of the Black Sea deal. Oil market tightness to persist Oil prices have strengthened over the summer, with ICE Brent convincingly breaking above US$80/bbl. The strength in the flat price has coincided with strength in time spreads, reflecting a tightening in the physical oil market. OPEC+ cuts, and in particular additional voluntary cuts from Saudi Arabia, mean that the market is drawing down inventories. We expect this trend will continue until the end of the year, which suggests that oil prices still have room to move higher from current levels. While the fundamentals are constructive, there are clear headwinds for the oil market. Firstly, it is becoming more apparent that the Fed will likely keep interest rates higher for longer and that, along with renewed USD strength, is a concern for markets. Secondly, Chinese macro data continues to disappoint, raising concerns over the outlook for the Chinese economy and what this ultimately means for oil demand. That said, up to now, Chinese demand indicators remain pretty strong. We expect the tight oil environment to persist through much of 2024 with limited non-OPEC supply growth, continued OPEC+ cuts and demand growth all ensuring that global inventories will decline. However, we could see some price weakness in early 2024, with the market forecast to be in a small surplus in the first quarter of next year before moving back into deficit for the remainder of 2024, which should keep prices well supported. The risks to our constructive view on the market (other than China demand concerns) include further growth in Iranian supply despite ongoing US sanctions and a possible easing in US sanctions against Venezuela, which could lead to some marginal increases in oil supply.

The Commodities Feed: Oil spreads strengthen Sentiment in the oil market remains constructive. Price direction in the immediate term will be dictated by what Saudi Arabia and Russia decide to do with their supply cuts. Energy- Further escalation in LNG labour talks The oil market managed to edge higher yesterday with ICE Brent settling at US$89/bbl, although trading volumes were relatively subdued owing to a public holiday in the US. Sentiment in the oil market remains largely constructive, particularly with a largely bullish narrative coming out of the ongoing APPEC week in Singapore. In addition, the oil market is waiting and expecting Saudi Arabia to extend its additional voluntary supply cut, while Russia is also expected to extend its cuts. Given market expectations, it is unlikely that the two producers would stray away from an extension and so risk a sell-off in the market. The strength that we have seen in the flat price over the last week has been accompanied by stronger time spreads, with the prompt spread strengthening to a backwardation of US$0.75/bbl, up from US$0.39/bbl at the start of last week. Meanwhile, the Dec’23/Dec’24 spread is now trading above US$6/bbl. These stronger spreads suggest that we will continue to see a tightening in the physical market, something which our balance sheet also shows through until the end of this year. Given that the market is only expected to tighten further, this suggests that there is room for further upside in both the flat price and time spreads. As for natural gas, negotiations between Chevron and unions do not appear to be progressing well. Partial strike action at the Gorgon and Wheatstone LNG facilities in Australia is set to commence on 7 September. However, the Offshore Alliance has now said it has served Chevron with a further notice for full rolling stoppages from 14 September. This is likely to provide some support to gas prices today and comes at a time when there is ongoing maintenance work at the Norwegian gas field, Troll, which has seen flows from Norway falling to around 130mcm/day, compared to more than 300mcm/day in mid-August.

US industry posts solid gains, inflation expectations plunge Another respectable industrial production report while the University of Michigan reported a big plunge in inflation expectations. All this should be music to the ears of the Federal Reserve as it seeks a soft landing for the economy and a return to 2% inflation. Decent industrial output, but strike action could weigh in coming months As with the retail sales report, the US industrial production number beat expectations in August, but the downward revisions to July means that on balance the level of activity is broadly in line with what was expected. This has been a bit of a trend of late with big prints subsequently getting some chunky downward revisions, be it in manufacturing, consumer spending, jobs or GDP. In terms of today’s numbers, US industrial production rose 0.4% in August versus the 01% expected, but there was a 0.3pp downward revision to July's growth (from 1% to 0.7%). Manufacturing rose 0.1% as expected, but there was a 0.1pp downward revisions to July from 0.5% to 0.4% growth. Auto output fell 5% month-on-month after a 5.1% jump the previous month with manufacturing ex vehicles rising 0.7%, led by a 2% jump in machinery manufacturing. Outside of manufacturing, which makes up 74% of total industrial output, utilities output rose 0.9% while mining increased 1.4%. On balance the report is OK and is stronger than what is implied by the manufacturing ISM report, which has been in contraction territory for 10 consecutive months. However, auto output is up near record highs. Strip this out and the chart below shows there is a much tighter relationship between the ISM and non-auto related manufacturing. Today’s report won’t swing the Fed debate in either direction meaningfully. The key story for manufacturing next month will be how much the UAW strike action hits output. So far it is starting out modestly with just 12,700 on strike, but could quickly escalate and hit output hard. ISM manufacturing index versus non-auto manufacturing output (YoY%) US consumer inflation expectations fall sharply University of Michigan confidence fell more than expected to 67.7 from 69.5 (consensus 69.0). The perception on current conditions fell six points while expectations rose 0.8 points. Remember this index is much more responsive to inflation-related issues while the Conference Board measure of confidence is more reflective of the labour market (hence why the Conference Board suggests everything is great, with unemployment below 4%, yet the University of Michigan measure of sentiment suggests the world is on the cusp of falling apart). Rising gasoline prices are the likely culprit depressing today's report as households feel the hit to spending power it generates elsewhere. Yet, rather bizarrely, we have some big declines in inflation expectations which should be music to the ears of the Fed. 1Y inflation expectations are down to 3.1% from 3.5% – it is actually below the current level of inflation – while 5-10Y expectations dropped from 3% to 2.7%. Both are really big surprises, but the usual caveat applies that they use fairly small sample sizes and things can swing. Nonethless, on balance this is further evidence that backs the Federal Reserve's claims that it can achieve a soft landing for the economy while returning inflation sustainably to target.

Rates Spark: Hawkish tail risks The week kicked off with a bearish tone in rates markets, with key central bank decisions just ahead. Ever-rising energy costs only add to fears that the inflation fight is not yet decided. ECB hawks offered more pushback against an overly dovish interpretation of last week's hike, and the focus is shifting to other means of policy tightening than just rates. A bearish tone in markets to start the week, and a renewed discussion of the ECB balance sheet Ahead of the key Fed and Bank of England meetings, the week kicked off with a bearish tone in rates. It was, in particular, the front end that showed weakness in the US, with the 2Y US Treasury rate pushing further above 5%. The outlier was the UK, where it was more the belly of the curve and rates further out that led rates higher – perhaps it is the “Table Mountain” comparison used by the BoE’s Chief economist gaining more attention. But more broadly speaking, it could also be markets bracing for more hawkish tail risks to their longer views. With a view to the European Central Bank, which had signalled that rates had reached a level which, if held long enough, would make a “substantial contribution” to reaching the inflation goals, markets are having second thoughts about their initial dovish interpretation. Oil prices are pushing higher, EUR market-based inflation expectations, i.e., longer-term inflation swaps, are not coming down, and real interest rates still remain well below the July highs. The decline of the latter, Isabel Schnabel had cautioned ahead of the European Central Bank's meeting, could counteract the ECB’s inflation-fighting efforts. So it may not be all that surprising to see the ECB’s hawks come to suggest it was too early to call the peak, with some also suggesting now is the time to think about speeding up the reduction of the balance sheet. If rates contribute substantially to reaching the inflation target, can the balance sheet provide the minor remainder that is needed? Next to the ECB officials’ remarks, the key piece of news yesterday was a Reuters background story that the ECB wants soon to tackle the high level of excess reserves in the banking system. Basically, there are two ways this could be done, either via raising the minimum reserve requirement for banks or via the speeding up of quantitative tightening. According to the article, several policymakers favour raising the reserve ratio from the current level of 1%, which currently is equivalent to around €165bn, to closer to 3% or 4%. As the ECB recently also decided to drop the remuneration of required reserves to 0%, it would also have the benefit of reducing the ECB’s interest rate costs. Most saw room to phase out the Pandemic Emergency Purchase Programme (PEPP) by ending the portfolio’s reinvestments earlier. But all were 'nervous' about the potentially negative impact on sovereign spreads. The argument against outright selling of the other portfolios under the Asset Purchase Program (APP) was that it would crystallise mark-to-market losses, highlighting the ECB’s concern with interest rate costs. Perhaps the article's main take-away on quantitative tightening is that any decision might not come this year and would take effect only in “early 2024 or even later in the spring”. The ECB still has work to do Today's events and market view In terms of outright direction, the sell-off in Bunds could slow with 10y yields having pushed above 2.70%, which could also mean that the curve flattening has more room yet. Elsewhere, US politics, with a potential government shutdown and strike action, is muddying the outlook for US rates. It could also imply a bit more caution from the Fed. Data today includes final CPI data out of the eurozone and in the US housing starts and building permits data for August. In government bond primary markets, Finland will tap 7y and 10y bonds for €1.5bn in total. Outside the eurozone, the UK will tap the 30Y Gilt for £2.75bn and later in the day, the US Treasury taps the 20Y bond for US$13bn.