Why Oil Prices Plunged Today

By Nick Cunningham

oil pipeline

Oil traders – along with financial markets everywhere – were disappointed with the decision by the U.S. Federal Reserve despite the first interest rate cut since the global financial crisis a decade ago.

The Fed cut rates by 25 basis points on Wednesday, and one would think that the monetary easing would push up equities and commodities. Crude oil, priced in dollars, tends to benefit with the central bank cuts rates, as it tends to weaken the dollar and make oil more affordable for much of the world.

However, markets were clearly disappointed. Stocks plunged late Wednesday and oil opened up sharply down on Thursday. The dollar was up while WTI and Brent were off by nearly 3 percent.

The Fed said that it was acting in order to sustain the economic expansion, but the decision had some dissenting votes. Some on Fed’s board opposed a rate cut at all due to the strength of the economy. But financial markets really fell after Fed Chairman Jerome Powell essentially said that the central bank was not embarking upon an extended period of loosening.

The financial markets had largely baked in at least a 25 basis point cut, and had been hoping for more.

“The position is not well enunciated. The policy statement was ambiguous and frankly he hasn’t done anything to clarify it,” Ward McCarthy, Jefferies chief financial economist, told CNBC. “He seems like he’s not confident. My take is they’re worried about downside risks. Since they’ve already taken the step [to cut rates], they’ll probably take another, but his comments and the two dissents suggest this is not the beginning of a major easing cycle and that’s what hammered the market.”

Related: Oil Crashes As Trade War Escalates

The disappointing announcement was compounded by some poor economic data. U.S. manufacturing activity fell to its weakest rate in three years, according to the Institute for Supply Management. In July, manufacturing activity in the Eurozone contracted at its fastest rate since 2012. That could prompt another round of easing from the European Central Bank. “The euro zone PMI dashboard is a sea of red, with all lights warning on the deteriorating health of the region’s manufacturers,” said Chris Williamson, chief business economist at IHS Markit, according to Reuters.

Global air freight demand declined by 3.4 percent in May, the seventh consecutive month of contraction, perhaps another sign of a weakening economy. Falling air traffic would have a knock on effect on jet fuel demand and ultimately crude oil demand.

“Looks like the market did not like the one-and-done Fed decision yesterday,” Kyle Cooper, director of research at IAF Advisors, told Bloomberg. “Traders are shifting their focus and getting a bit nervous about uncertainty surrounding demand, especially since China- U.S. trade talks have stalled again.”

That all came before the really big market news on Thursday.

Seemingly out of nowhere, President Trump tweeted that the U.S. would hike tariffs on China’s remaining $300 billion worth of imports. A 10 percent levy would hit those goods on September 1.

Markets plunged on the news, with crude oil off a massive 8 percent.

The U.S.-China trade negotiations have largely gone nowhere. The two sides wrapped up a brief round of talks this week, “with little sign of progress apart from an agreement to meet again next month,” Reuters reported.


It’s not hard to imagine Trump’s trade negotiators reporting back about the lack of progress on trade talks, leading the president to pick up his phone and take to twitter.

Earlier, President Trump had appeared resigned to the possibility that no deal was likely before the 2020 election, tweeting that China was likely waiting him out in hopes of a new president.

The escalation of the trade war creates a whole new mess for the oil market. Higher tariffs will hit demand in China and potentially slow down both economies – and have knock on effects for the global economy. All of that is hugely negative for crude oil. The problem is that the oil market was facing a looming supply surplus anyways, with demand badly trailing supply growth.

By Nick Cunningham of Oilprice.com



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