Introduction
Oil has rebounded from the July low of $95.90 on Brent Crude oil. The market has since looked to stabilise above support. However, it is becoming increasingly clear that oil is now moving around with switches in risk appetite and the performance of the US dollar. The market is again rallying to test key technical barriers that stand in the way of continued recovery. However, for the move to be sustainable, it is likely to need a positive bias to risk appetite and, with that, a weaker dollar.
- Oil and USD are negatively correlated
- The technicals are at a key crossroads in the medium-term outlook
Oil and USD are negatively correlated
The moves in oil in the past couple of weeks have become very closely tied to that of the USD. A USD correction has come at the same time that oil has started to recover. There is sound reasoning behind this:
Recession fears have driven USD strength in recent weeks. Recession fears have been hitting the outlook for oil demand. Subsequently, when news broke that the Fed would not be pushing ahead with an ultra-aggressive +100bps hike in July, not only did the USD correct, but oil also rallied.
Since then, market moves that have been USD negative have helped to support oil.
Looking at the chart of oil versus the USD, we see that the two have a consistent negative correlation. It averages around -0.16 on a 12-month basis. This is not exceptionally strong, but the correlation has been very strong in the past couple of months.
Therefore, we believe that a market outlook that supports the USD will be oil negative. Subsequently, the Fed meeting tomorrow could be crucial for the near-term outlook for oil. If the Fed confirms a less aggressive policy stance, USD could continue to correct. This would though be positive for broader sentiment and also act as support for oil.
Technicals at a crossroads
As this crucial Fed meeting approaches, we see the outlook for Brent Crude oil (UKOUSD) has recovered again to an important crossroads:
- Price resistance between $107.65/$109.65 is being tested for the third time in July
- Six-week downtrend channel resistance is also under threat
- The falling 21-day moving average which has capped the upside since mid-June is also being tested.
- The daily RSI has rebounded into 45/50 where the rallies have all failed during this downtrend phase
If these technical indicators begin to be broken to the upside it would signal a decisive shift in the medium-term outlook. A close above $110 would be a signal for a more bullish outlook for oil. It would complete a base pattern that would imply upside towards $120/$125 in the coming weeks.
For now, our preferred trading strategy is to play this downtrend channel and sell into strength for further pressure on $98/$100 support. However, this could change with the Fed meeting tomorrow. A less aggressive Federal Reserve monetary policy (a steer towards fewer rate hikes by the end of 2022) would likely hit USD strength, and help to support moves for a higher oil price.
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This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
