Energy trader positioning has been heavily long oil and that trade seems to be unwinding. I am guilty of not weighing enough importance on market positioning in initiating a $60 WTI price target back in December. While initially thrusting higher per expectations on satisfactory OPEC compliance during the first two months of 2017, there were not enough new buyers in the market to push WTI to the full $60 target before the fundamental theme deteriorated somewhat.
Record US crude inventories, as well as increased production in countries excluded from the OPEC deals, such as Iran and Libya, nearly filled the 1.2MM bpd supply gap left by those who participated in the deal. While the core theme of Saudi Arabia doing whatever it takes to avoid another oil market crash still stands, upside is now more limited. The new WTI range is likely to be $43-51 per barrel, with an outside chance of reaching the downside technical support level just below $40. I now have a 2017 Q2 price target of $46 WTI.
A moderated crude oil outlook has implications for the Fed’s monetary policy as it will allow inflation to plateau without the wheels coming off from a continued interest rate spike. Global central banks are being partially saved by shale oil producers in rural America. I expect a 25 bp hike tomorrow with no more than 1 or 2 more hikes this year. I also see the Fed beginning to reduce the size of its balance sheet in Q4, which along side energy price moderation, could even take a third hike for the year off the table.
The secular bond bull market may be behind us, but bond prices have fallen too far, too fast. Expect a short to medium term pause in bonds, especially if the 10y Treasury reaches 2.75% in the near term. A non-consensus, cautious long position in TLT or BLV is much more attractive now than it has been in months, but this is not a long term call by any means.
Finally, I expect some near term moderation in USD gains to turn into a mild pullback in the greenback after the Fed likely hikes the target rate tomorrow. The risk/reward for fresh long dollar positions is poor against nearly any cross, particularly NZD, JPY, and EUR. Wait for a more favorable dealing rate if you are chomping at the bit to get long USD.