Does Crude’s Plunge Suggest a Global Economic Slowdown?

Oil is in a bear market, falling below $56/bbl for the first time this year. Adding insult to injury, spot crude suffered a 7.1 per cent plunge earlier this week – its worst daily return in three years. A pullback of this magnitude in such an integral industrial input has investors worried that it’s a harbinger of a global slowdown. Earlier this week OPEC trimmed is global demand forecast for this year and next, blaming lower-than-expected demand in the Middle East and China.

Yet oil production is on the increase among OPEC countries and the US. OPEC production has exceeded 32 million bpd consistently since June, and has no formal plan to trim output. Meanwhile, the US oil rig count at 886 is 20 per cent higher than it was this time last year.

Does the oil price plunge suggest a global slowdown? In our view this is unlikely. As with any tradable instrument, oil’s price is determined by supply and demand. We estimate that most of this year’s price decline has more to do with supply than it does with flagging demand. One indicator that underscores our view is crude’s relationship with Treasury yields. Under normal supply environments, oil prices and interest rates move in tandem as stronger demand implies more robust growth, and vice versa. The most recent crude selloff is not coupled with a parallel downtrend in rates. We conclude that the oil complex is in its own world of woe thanks to ambitious output levels and that the low price of oil does not portend impending economic doom.

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