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Macro Market Update- Oil Prices

Updated: Mar 23, 2019

Authors: Jerusan Jegatheeswaran Co-VP Education/ Research, Dragos Cada Co-VP Education/ Research, Alice Li Research Analyst, Amy Li Research Analyst, Helen Feng Research Analyst, Julia Tu Internal Analyst

Oil Prices Decline on Rising Inventory and Trade Deficit

On Wednesday, oil prices fell more than 0.5% after two big U.S. producers released bullish reports showing an unexpectedly large rise in crude oil inventory. This fueled fear of domestic oversupply. U.S. crude inventories rose by 7.3 million to 451.4 million barrels, compared to analysts’ expectation of an increase of only 1.2 million barrels. This large stock build is a bearish signal and adds to concerns over the U.S. - China trade deal. On Monday, U.S. oil standard West Texas Intermediate futures closed 0.6% lower at $56.22 a barrel on the New York Mercantile Exchange.

Brent Crude, Global Oil Benchmark Price in May 2019

OPEC Agreement

OPEC, de facto led by Saudi Arabia, and a group of 10 producers outside the cartel, led by Russia, agreed late last year to collectively hold back crude production by 1.2 million barrels a day for the first half of 2019. The agreement was aimed at tightening the markets. Combined with the ongoing U.S. sanctions on Iran and Venezuela, it has led to lower supply from the cartel this year. After a 40% drop in prices in the fourth quarter of last year, crude prices rose about 20% year-to-date due to this agreement.

Interestingly, oil prices began to rise on Thursday due to the support from the OPEC supply cuts and U.S. sanctions. However, these gains were capped by record U.S. crude production and falling estimates of global economic growth.

Rising Trade Deficit

A broader trade deficit has been putting more pressure on oil prices. U.S. Commerce Department reported that last year, the trade deficit rose to $621 billion, the highest since 2008. Trump’s various attempts at trade negotiations and tariff increases seem to have been ineffective at reducing this gap. This weaker growth could decrease oil demand and affect oil prices. Investors are starting to realize that the trade war is not beneficial to the market after the bearish report.

Interest Rates are Held Steady

Background on How Interest Rates are Set

Banks typically want to aim for its benchmark destination rate of between 2.5% - 3.5%. This rate is calculated based on the preferred rate when the economy is operating at full capacity and when inflation is within 1% - 3%.

When deciding whether to raise interest rates, banks will take into consideration the impact that this will have on indebted Canadians, the housing market and the global trade environment. Generally speaking, low interest rates will result in stronger economic growth. This is due to the fact that people can pay less interest to borrow money which encourages more borrowing and spending, thus creating more economic activity and stimulating economic growth. However, this would also result in a rise in inflation, likely over the top of the bank’s inflation range. Thus, when setting interest rates, banks must look for a balance between encouraging economic growth while also controlling inflation rates.

The bank will meet 8 times a year to set its interest rate. As seen in the graph below, the bank raised interest rates 5 times since July 2017 to arrive at the current 1.75% interest rate, the reason being to prevent inflation rates from getting too high.

Recent News of Interest Rates

Last Wednesday, the Central Bank of Canada announced their decision to continue keeping interest rates at the benchmark rate of 1.75% due to concerns about the global economy and Canada’s own recent performance. The central bank stated that slowdown in the world economy was more than anticipated in their January forecast and trade uncertainty has also affected economic performance around the world, despite recent progressions in the U.S. - China trade talks. The bank also pointed to a greater slowdown on Canada’s oil patch as well as weakness in the housing market and consumer spending.

Future Interest Rates

Interest rates have been held steady at 1.75% since October 2017 and future bank rate increases are highly uncertain but will depend on developments in household spending, oil markets and global trade policy. TD Bank economist Brian DePratto predicts that, "unless we see a robust growth recovery mid-year … further rate hikes in 2019 are all but off the table." Judging from the current state of the economy, it seems that a rate increase is unlikely to happen until the second half of the year. In fact, there is an 8% change of a potential rate cut next month, which would be the first cut since 2015.

Weak Economic Growth

Last week, Statistics Canada released a report that showed the country delivered its weakest quarter of economic growth in two and a half years. Economic growth slowed to an annualized pace of just 0.4 %. It was reported that the central bank had been expecting a drop in household spending as well as weak numbers for exports and investment in oil-producing provinces in the fourth quarter.