Home Business Oil prices and financial markets brace for recession: Kemp

Oil prices and financial markets brace for recession: Kemp

13 min read
Comments Off on Oil prices and financial markets brace for recession: Kemp


Article content

LONDON — U.S. economic data remains strong but a range of financial indicators point to a sharp slowdown over the next year that would dampen oil consumption and lead to lower prices.

The apparent contradiction between the real economy and financial markets has puzzled some commentators but is normal around a peak in the business cycle.

Article content

Economic data reflect current conditions while financial prices reflect how traders expect the economy to evolve in future (https://tmsnrt.rs/3BgAVbP).

Advertisement 2

Article content

By definition, every downturn starts from a peak in the business cycle when activity is strong. The rapid shift from strong and rising economic activity into a contraction is what makes turning points hard to predict.

In recent decades, the largest forecasting errors have occurred around turning points, especially peaks (“Business cycles: theory, history, indicators and forecasting”, Zarnowitz, 1992).

But financial markets currently assign a high probability to a significant slowdown in the cycle in the next 6 months, possibly qualifying as a recession, notwithstanding the high level of economic activity and jobs.


Global trade volumes and industrial output remained at or very close to record levels in June, according to the Netherlands Bureau for Economic Policy Analysis (“World trade monitor”, CPB, Aug. 25).

Advertisement 3

Article content

U.S. freight volumes were at record levels in June and manufacturing output was close to its highest levels since before the financial crisis, based on data from the U.S. Bureau of Transportation Statistics and the Federal Reserve.

Manufacturing activity continued to increase through August, albeit more slowly than before, according to surveys conducted by the Institute for Supply Management.

The ISM composite purchasing managers’ index remained at 52.8 in July and August, slightly above the 50-point threshold that divides expanding activity from a contraction, and in the 50th percentile for all months since 1980.

But a broad range of financial indicators from fixed income, equity and commodity markets, as well as individual share prices for bellwether companies, all point to a significant slowdown in the cycle in the next six months.

Advertisement 4

Article content


Futures prices imply the U.S. central bank is expected to raise interest rates over the next six months to 4.25-4.50% before April 2023 from 2.25-2.50% at present, shocking borrowers and the economy.

The U.S. Treasury yield curve between securities maturing in two and ten years’ time is more inverted than at any time since August 2000 when the dotcom bubble was starting to burst.

Financial conditions are tightening at some of the fastest rates for more than a decade, based on the Chicago Fed’s Financial Conditions Index, which is based on measures of risk, credit and leverage.

U.S. equity indices have already slumped as investors anticipate a downturn hitting demand and discount future earnings more heavily.

Advertisement 5

Article content

After adjusting for inflation, the broad U.S. S&P 500 equity index is down by around 13-14% compared with the same period last year.

Individual equities closely linked with the cycle, including Caterpillar, the heavy equipment maker, and 3M Corporation, the diversified manufacturer, have fallen sharply, consistent with a significant economic slowdown.

South Korea’s KOSPI-100 index, which tracks the global trade cycle because of its heavy exposure to export manufacturing firms, is also down by more than 23% compared with the same point last year.


The expected business cycle slowdown is evident in fuel markets, where spread between European gas oil and Brent crude futures for deliveries in April 2023 has softened to $30 per barrel from more than $40 in late August.

Advertisement 6

Article content

Gas oil’s calendar spread between December 2022 and December 2023 has fallen to a backwardation of $12 per barrel from $26 in late August and $33 in June, implying that inventories are expected to be higher than before.

Gas oil and other middle distillates are the workhorse of manufacturing and freight transportation and the most sensitive to changes in the business cycle.

Softer spreads are consistent with a regional and global slowdown that would allow distillate inventories to be rebuilt from their current very depleted level.


Prices for bonds, equities and commodities reflect what is expected to happen not what will – and those expectations could change or be proved wrong.

But financial markets assign an unusually high probability to an imminent recession at the moment so the expectations cannot be dismissed lightly.

Advertisement 7

Article content

In the event that a significant cyclical slowdown occurs, it is likely to be more severe in Europe and China than in the United States.

Europe is more directly exposed to the fallout from energy prices, high inflation and the possible disruption of gas supplies stemming from Russia’s invasion of Ukraine.

China is struggling with a persistent cycle of city-level lockdowns imposed to stop the spread of coronavirus as part of its epidemic control strategy.

But spillovers from Europe and China as well as a massive tightening of financial conditions at home are expected to induce a significant slowdown in the United States itself.

Slower growth in the big three economies will also spill over into the larger emerging economies, including India, Brazil, Saudi Arabia, Indonesia, Turkey, Mexico and Thailand.

If the expected slowdown materializes, energy consumption will grow much more slowly in 2023, taking some of the heat out of prices for coal, gas, diesel and crude.

Related columns:

– European gas oil futures anticipate recession (Reuters, Aug. 8)

– U.S. diesel shortage shows economy hitting capacity limit (Reuters, Aug. 4)

– Oil and interest rate futures point to cyclical downturn before end of 2022 (Reuters, July 22)

John Kemp is a Reuters market analyst. The views expressed are his own (Editing by Elaine Hardcastle)



Postmedia is committed to maintaining a lively but civil forum for discussion and encourage all readers to share their views on our articles. Comments may take up to an hour for moderation before appearing on the site. We ask you to keep your comments relevant and respectful. We have enabled email notifications—you will now receive an email if you receive a reply to your comment, there is an update to a comment thread you follow or if a user you follow comments. Visit our Community Guidelines for more information and details on how to adjust your email settings.


Source link

Load More Related Articles
Load More By 
Load More In Business
Comments are closed.

Check Also

When is the Right Time of Year to Transport Your Vehicle?

Transporting a vehicle can be a stressful experience, especially if you are unsure about t…