Risk off slows as oil explodes higher

Markets enter another day of conflict in Ukraine, battered by uncertainty and the threat of more sanctions from the West. The “nuclear” option of hitting Russia’s energy markets has not yet come to pass, but the increasing military threat, as Russian forces gather outside the Ukrainian capital city only adds to the tension and likelihood of this happening.

In the meantime, oil and gas markets are surging higher again this morning while other euro assets get sold.

Oil in the crosshairs of conflict

Brent crude settled more than 7% higher yesterday and strength is continuing in early trade today, with prices making fresh seven-year highs at $112.72.

The threat of oil sanctions together with the difficulty in trading Russian oil is pushing prices ever higher.

Russia is the world’s third largest crude producer and the second biggest exporter. Banks are now refusing to handle Russian oil transactions which means around 70% of its oil exports are finding no buyers.

The IEA announced a release of 60 million barrels of oil yesterday in an attempt to stem the rise in prices. But traders had expected a larger release and, in any event, this is seen as simply a very short-term solution. OPEC+ meet today and, in line with general expectation, the cartel has stuck to its plan of increasing production by 400k bpd in April.

Some members have recently said that the current price strength reflects geopolitical issues rather than any supply/demand imbalances. How long this argument holds is the key question.

Crude prices are overbought and extended on several timeframes and technical indicators at present. But that doesn’t mean they can’t go higher in this extreme environment. Round numbers are upside targets now, so $115 and $120. Support should come around the last week’s high in Brent at $102.08.

Higher rates versus hit to growth

Investors have been torn between pricing two very different scenarios. One where the conflict, sanctions and risk of escalation hit economic activity, and one where underlying growth is robust enough to warrant higher rates. It seems especially in the Eurozone, and even allowing for this mornings’ all-time high in the region’s inflation (which is only going higher), markets are siding with the negative impact to growth.

There appears to be a stagflation shock of epic proportions coming. That is when growth slows while inflation goes higher.

Bond yields collapsed yesterday with the biggest move in German 10-year yields this century, taking them into negative territory again. UK yields also tumbled as investors dialled down their bets on rate rises. The 10-year gilt yield suffered its biggest one-day decline since the day after the Brexit referendum in June 2016.

A big dovish repricing is going on which means the ECB especially are liable to move slowly in any form of policy tightening.

EUR/USD to new lows

This has seen the euro get offered, with the region’s growth outlook taking potentially a 1%+ hit this year due to the Ukrainian crisis. One month options in EUR/USD have hit levels last seen during the March coronavirus panic.

Today’s selling in the world’s most traded currency pair has taken it below the previous cycle lows just above 1.11.

Unless there is any positive news around peace talks, prices will drift lower down towards 1.10.

 

risk sentiment Oil Brent OPEC+ Ukraine crisis Russia Euro EURUSD stagflation ECB European Central Bank