Oil Prices Stabilize; RBA Cuts Rates

Oil prices recovered slightly early Tuesday, after both major benchmarks WTI and Brent entered a bear territory on Monday, falling by more than 20% from their June peaks.

The same factors which dragged prices to a 13-year low in Jan 2016 are back in play. It’s all about the oversupplied market. The rebalancing of supply and demand which was expected to happen in the second half of the year seems to have pushed out towards 2017 as disrupted supplies resumed, OPEC’s output expected to increase to record highs, and rig counts continued to rise in the U.S.

The discount provided by Saudi Aramco for its Arab Light crude oil for Asian customers by $1.30 a barrel reflects the ongoing aggressive competition for market share with other big producers within the cartel such as Iraq and Iran. If similar actions are taken by rivals we expect more downward pressure on prices in the short run.

Pessimism amongst speculators was also reflected in latest CFTC data, which showed that bearish positions for WTI rose to record highs and bullish bets dropped to their lowest levels in 5 months. However, I continue to see long-term opportunities as prices drift below $40 a barrel, with a potential to rise back to June’s high around $50 in Q4 2016 as we get closer to rebalancing in supply and demand.

In the commodity currencies space, AUD/USD fell below 0.75 as Reserve Bank of Australia cut its benchmark lending rate to a record low of 1.5%. RBA was the first major central bank to act post U.K.’s referendum vote, and now all eyes will be on Bank of England on Thursday with market expectations high for the central bank to follow suit.

According to RBA’s statement, “economic growth continued at a moderate pace”, suggesting that inflation was the major factor leading to the decision. If prices remain stubbornly low in Q3, I expect another rate cut in 2016 which will add further pressure on the Aussie.

Markets are awaiting Prime Minister Shinzo Abe’s cabinet to approve the 28 trillion-yen stimulus package today. However, direct fiscal spending will likely be a quarter of the total package which might disappoint markets and lead to further gains in yen unless more aggressive action is taken.

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