Oil Futures Chase Equities Lower on Fear of Fed Rate Hikes

Liubov Georges
By  Liubov Georges , DTN Energy Reporter

WASHINGTON (DTN) -- Reversing an early advance triggered by China's easing of COVID-19 quarantine restrictions, oil futures nearest delivery on the New York Mercantile Exchange and Brent crude on the Intercontinental Exchange followed equity markets lower Monday afternoon. That sent both the U.S. and international crude benchmarks 3% lower amid fear the Federal Reserve would continue raising interest rates that will eventually steer the U.S. economy into recession.

More evidence of a resilient consumer could be found in November services data released Monday morning by the Institute of Supply Management that showed business activity in the service economy strengthened last month despite efforts by the central bank to drawdown excessive demand. The Business Activity Index registered 64.7% in November, a substantial increase of 9% compared to the October reading, with the headline number for Services PMI clocking in at 56.5%. A reading of 50% separates growth from contraction.

The accelerated growth in the service economy was realized on the back of increases in business activity but also employment. The employment index climbed out of contraction territory to 51.5% in November, reflecting consistently strong growth in the labor market. Last month, the U.S. economy added a robust 263,000 new jobs, with notable gains occurring in professional and services industries. What's more surprising, hourly wages for all employees spiked 0.6% from the prior month -- double what economists had expected.

These data points are bad news for the Federal Reserve as they suggest the central bank has made little progress so far in cooling off a red-hot labor market along with inflation. Following a Nov. 30 speech by Fed Chairman Jerome Powell, investors largely expect the Federal Open Market Committee to agree on a 0.5% hike in the federal funds rate their Dec. 13-14 meeting. That would mark a step down from a series of four straight 0.75% rate hikes. Former Treasury Secretary Lawrence Summers, however, warned that the Federal Reserve will probably need to raise interest rates more than markets are currently expecting.

"For my money, the best single measure of core underlying inflation is to look at wages. My sense is that inflation is going to be a little more sustained than what people are looking for," said Summers.

Interest rate futures suggest traders expect the central bank to raise the federal funds rate to 5% by May 2023 compared with a current target range of 3.75% to 4%.

Further weighing on the oil complex, Saudi Arabia on Monday morning lowered most of its oil selling prices for Asia, its key market, in a sign that demand remains fragile amid continued zero-COVID policies in China. State-controlled Saudi Aramco cut its key Arab Light grade for January sales to Asia by $2.20 to $3.25 per barrel (bbl) above the regional benchmark. The move was in line with analysts' calls for a drop of $2.10, according to a Bloomberg survey.

Saudi Arabia's fellow OPEC member Kuwait on Friday said that oil customers were reluctant to boost imports into early next year. There have been reports suggesting that Chinese refiners are pulling back on January oil purchases amid regulatory uncertainty surrounding lockdowns. Saudi Arabia also reduced most of its prices for European customers, while leaving those for the United States unchanged. Aramco's decision came a day after the Organization of Petroleum Exporting Countries and allied producers, led by the Saudis and Russia, agreed to maintain output quotas into early next year.

At settlement, West Texas Intermediate January contract fell $3.05 to $76.93 per bbl, and February Brent futures on ICE declined by $2.89 to $82.68 per bbl. January RBOB futures on NYMEX dropped to $2.2019 per gallon, down by $0.0785, and the January ULSD contract tumbled $0.1687 to $2.9998 per gallon.

Liubov Georges can be reached at liubov.georges@dtn.com

Liubov Georges