As the saying goes, all roads lead to Rome. Although the idiom originates from the era of the Roman Empire it is very fitting today when you replace Rome with Covid. In the last 18 months every talking point, development, decision, or market-moving news has been, directly or indirectly, linked to the management of the ongoing health crisis. It was no different last month. Whatever event had an influence on investors’ sentiment they were all shaped by the pandemic. Think of the growth forecast from the IMF, central banks’ modus operandi in ensuring prolonged economic growth, the guessing game of the sustainability of inflationary pressure or the actions of the central bank of the oil market, the OPEC+ alliance. The nervousness was tangible in July as it was as unambiguous as ever that the invisible enemy has not been fully defeated yet. Nevertheless, optimism persisted and is likely to persist in coming months.
Economic growth: the IMF released its latest growth forecast and whilst global expansion remains unchanged at 6% in its view regional differences are widening. Emerging and developing markets will grow at 6.3%, 0.4% less than predicted in April. Growth rates, on the other hand, have been revised up by 0.5% to 5.6% in advanced economies. The reason behind this gap is the uneven spread of the Delta variant, which causes greater suffering in the developing part of the world due to the availability of inoculation. Whilst the UK, for example, is opening its borders for double-vaxxed travellers mobility restriction and lockdowns have been re-introduced in several countries in the Far East. Although the Delta variant is quickly becoming the dominant strain it has, so far, had a muted effect on hospitalization, consequently financial markets, generally speaking, have not been rattled. Intensive inoculation programmes would help ease the vaccine inequality that slows down but does not derail global economic growth, at least not for the time being.
Monetary policy & inflation: central banks have started pondering about the path ahead. The question they are being asked is whether the time has come to scale back in their bond-buying programmes and provide concrete guidance on increasing interest rates. The European Central Bank’s Governing Council took its cue last month from the Fed as it revised its forward guidance on interest rates and changed its inflation targets to 2% over the medium-term, basically allowing it to overshoot this benchmark for a certain and undefined period of time. The Bank of Japan was blunter, and it confirmed that it would maintain its ultra-loose monetary policy. The Federal Reserve of the US acknowledged the progress the economy has made in recent months and hinted last week that it was a step closer to slowing down its asset purchase programme. With the same breath, however, it emphasized that the ultimate goals of price stability and full employment have not been achieved, therefore, the stimulus measures remain in place. The transitory inflationary pressure triggered by the worldwide jump in aggregate demand and supply chain bottlenecks does not justify the rise in interest rates and the withdrawing of bond-buying, the thinking goes. Investors tend to agree. The 10-year US Treasury yield dropped to 20 percentage points last month. Global stock indices remained stable in July whilst the US equity markets further advanced north. It is this supply chain bottlenecks and rising aggregate demand why July Chinese Factory activity disappointed and forced oil to start the new month on the back foot.
OPEC+: the ongoing economic recovery provides a stable backdrop to oil demand growth, but the supply side of the equation was briefly upended in July. The spat between the UAE and Saudi Arabia also originates in the health crisis. At the latest ministerial meeting increasing the group’s output level by 400,000 bpd between August and December seemed a foregone conclusion when the UAE rocked the boat. The Emirates demanded a change in reference production levels from which quotas are calculated citing a sizeable increase in its production capacity. The more than two weeks of stand-off understandably caused unease amongst oil traders.
In the middle of the month an ostensibly healthy compromise was struck. Base lines have been increased for five members (Iraq, Kuwait, Saudi Arabia, the UAE and Russia) out of the twenty countries with new output ceilings effective May 2022, after the current deal expires. Reference production will consequently rise from 43.853 mbpd to 45,485 mbpd. This would practically mean an increase of 1.632 mbpd in the group’s production level. Rising supply is generally considered bearish for oil prices, the latest agreement, however, is different. Firstly, it has removed a huge amount of uncertainty from the market and ensured prolonged co-operation between member states. Secondly, global oil demand for 2H of 2022 will be 2.9 mbpd above the corresponding period of 2021 (OPEC data) therefore an additional 1.6 mbpd of supply should be easily absorbed, provided all other parts of the puzzle remain unchanged.
And what about the balance of 2021? Taking into account the 400.000 bpd monthly increase in the group’s output level for the coming five months global oil inventories are set to deplete further. Demand for OPEC oil is forecast to stand at just over 29 mbpd for the second half of this year whilst the producer group is to pump around 600,000-700,000 bpd below that. Although the pace of stock depletion is slowing OECD oil inventories that are already below the 2015-2019 average are set to decline further supporting oil prices. The solid economic background and the continuous market management of the OPEC+ alliance strongly suggest stable to stronger oil prices for the rest of the current year with the often-cited $80/bbl target coming into sight towards the end of 2021.