Oil price settles above $100 per barrel as we wait for G7 news

The oil price is settling into life above $100 per barrel today. Although it has backed away from its highs of the day, the Brent crude price is still up 11%. Last week there was some optimism of a quick resolution to this conflict, this week the market is waking up to the real impact of this war, and the stagflation risks that it poses to the global economy.

G7 to the rescue?

Stocks are a sea of red today, although European markets have clawed back some earlier losses as we wait to see the outcome of the G7 finance ministers’ meeting to discuss the release of strategic oil reserves. The market has been somewhat calmed by the prospect of a coordinated release of strategic oil reserves by the G7 allies, however, there are still upside risks to the oil price, and anything the G7 does today may only have a temporary impact.

UK interest rate expectations does a 180 degree turn

The bond market is once again experiencing a deeper sell-off than equities. The UK bond market is getting pummeled today, as fears about stagflation rise. The UK 10 -year Gilt is higher by 12bps, this compares to a more moderate increase of 6bps for France and 3bps for Germany. There are a few reasons why UK yields are rising at a faster pace than elsewhere. UK Gilts had been one of the top global performers in the past 6 months, so there was room for bond prices to fall and yields to rise. Added to this, the BOE was expected to cut rates this year, compared to the ECB which was expected to remain on hold. As BOE rate cuts get price out by the interest rate futures market, this puts upward pressure on yields.

There has been a full 180-degree turn for UK rate cut expectations today, and the market is now expecting the BOE to hike rates this year, just under one hike is now expected by year end, as you can see below. This is a substantial move and rate hikes are now expected everywhere except the US, which is less exposed to an energy supply crisis, as the US is the world’s largest oil producer right now.

Stocks linked to the consumer are coming under pressure today. Stagflation is toxic for risk assets, and a fragile economic backdrop and an inflation mix make it hard to find safe harbours. Airlines and cruise stocks are in a bear market, while energy is the only sector in the green today.

Where does the oil price go next?

The question now is, where does the oil price go next? The Strait of Hormuz needs to reopen for the oil price to moderate significantly. The potential release of the Strategic oil reserves has already had a dampening impact on the oil price, but we don’t think this is enough to push crude below $100 per barrel for long. If the G7 also discuss providing alternative routes for ships to get oil and other commodities out of the Gulf then this could also dampen oil prices further and lift risk sentiment, but investors would want to see concrete action, and not just talk.

In the short term, the risk for oil, bonds and stocks is for further downside. Saudi has said that it is reducing oil output due to a storage glut. If it can’t get the oil out of country via the Strait of Hormuz, then it must stop production, which can take a long time to come onboard again.

The price action on Monday is a reaction to news about the supply constraints for major commodities in the Guld. This is the worst-case scenario, so unless things deteriorate further from here, the market may adjust to the realities of the conflict, and oil price rises and equity market losses could start to stabilize, although we don’t expect a meaningful recovery for as long as this war drags on and the Strait of Hormuz remains closed.  

This is still a headline driven market, and it’s a very fluid situation, so volatility is likely to persist for now.