The rising price of oil has become a huge problem for the global economy in recent months. The war in Ukraine has taken this problem to a whole new level. Markets have seen a whipsawing of prices in recent weeks, but the latest move back above $120 is a key breakout and opens upside once more. This will only add to the inflationary headache faced by central banks.

  • Supply constraints are all that matters right now for oil.
  • A technical breakout opens the highs again for Brent Crude.

Further supply issues drive oil higher

Several of the major central banks of the world are moving towards a tighter monetary policy. The Federal Reserve, the Bank of England, Reserve Bank of New Zealand, and the Bank of Canada have all started to hike rates, and they will likely continue throughout the year. This is in an attempt to control inflation, but will also hamper economic growth (i.e. economic activity) too. This should reduce demand for oil in the coming months.

However, any demand reductions are being swamped by the issues with supply. IFOr the oil price, the supply issues are all that matter. Oil spiked higher on the breakout of the war in Ukraine as talk of sanctions on Russian oil supplies emerged. Russia supplies around 10% of global oil. 

Brent Crude Oil (MT5 code: UKOUSD) spiked to $140 however, reversed sharply as peace talks supposedly started to find traction. A “long squeeze” (oil traders quickly moving to close long futures contracts) whipsawed oil lower, to $98.

However, in the past week, there has been concern over the lack of progress in peace talks and questions surrounding how genuine Russia’s intentions are. There is now supposedly a “short squeeze” that has sent oil sharply higher again. Volatility in oil options trading remains elevated and is moving even higher again. Anyone trading oil will attest to the fact that prices are extremely choppy right now.

Oil volatility

The cause of yesterday’s price spike higher was due to further supply issues, where storm damage to oil terminals in the Black Sea is expected to reduce Kazakhstani oil exports by up to 1 million barrels per day (or, c. 1% of global oil supply).

Inflationary oil

The eye-watering rises in the price of oil can only mean one thing. A further stoking of the fires of inflation. Inflation measures are already high (US CPI at +7.9% on a headline basis), and are expected to go higher. US inflation could hit 9% in the coming months. 

Long term US inflation expectations have also seemingly de-anchored in the past month. Having spent the past year, ranging sideways, the US 10 year Breakeven Inflation rate has shot higher by over 0.5% in the past month. Market participants are reacting too, with US Treasuries being sold off, sending bond yields ever higher. 

This all infers that central banks will need to deploy even tighter and perhaps more aggressive monetary policy. A higher oil price is certainly economically damaging.

US Inflation expectations

The technicals point to a higher oil price

The concerns are not helped by the technical analysis of oil either. Brent Crude oil moved through key resistance at $120.25 yesterday. With the market trending higher over the past week, this move has now broken through another key lower high. 

Here we see the 4-hour chart moving through the resistance and along an uptrend, flanked by the rising 21-period moving average. With strong momentum once more the way is open for a move higher towards $1333/$135. There is also not much resistance until there either.

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Here we also see strong technical momentum on the daily chart MACD lines. The bar has today crossed back above the signal line, which is a positive indication. 

Brent daily MACD

The big caveat for oil is any shift in newsflow. Any positive developments in the war in Ukraine (admittedly, with the stagnation in Russian advances and also peace talks, this is hard to see), will be negative for the oil price. The reason is that it would shift the outlook on supply again. 

On a technical analysis basis, moving decisively back below $120 would be a negative development, but it would need a breach of the near-term higher low at $113.40 to suggest a significant pullback may be underway.

This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.