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Crude Oil: The Most Important Chart in the World

Crude Oil: The Most Important Chart in the World

Crude oil is the only chart that matters again.

  • Momentum is currently to the downside, below the 200d moving average having sold off from $50 in early June

  • The first key support level is near at 41.88 (38.2% retracement of the Feb '16 - June '16 rally)

  • Should this fail, the next major support level is 35.84 (61.8% retracement of the Feb '16 - June '16 rally)

  • If the market finds support at either 41.88 / 35.84, then the 'reflation trade' is back on and targets a rally towards 59.72 eventually (38.2% retracement of the May '11 - Feb '16 decline)

  • If the market fails to find support and trades down through 35.84, then the 'reflation trade' is seriously challenged (perhaps reversed) and targets a decline below the February 2016 low of $26.05 ("$20 oil" scenario)

As a driver of global macro trading, the next move in oil is vital for several reasons;

  • According to a publication by the Atlanta Fed earlier this year, $40 crude would realise the Fed's 2% inflation target by year-end given the concealment of rising core measures by falling energy costs in headline CPI 0.00%% as a product of the decline in oil

  • In the meantime, core inflation has remained firmly above 2% whilst oil has almost doubled from the February 2016 low

  • Whilst YoY oil is virtually flat, the base effect of higher crude will really transpire in early 2017, assuming core inflation remains stable (it may even rise, and after all, is underestimated by econometric models e.g. "Shrinkflation")

  • In a negative / low yield world, there is currently little margin for inflation in bonds. If the above scenario plays out, expect the inflation risk premium in bonds to adjust sharply (yields higher)

  • The Fed has all but conceded 'stagnation', and the majority of investors still dont see a single increase in rates until March 2017 (according to implied probabilities from futures ) - evidence of complacency and consensus

  • Put simply, the bond market is being prevented from accurately pricing this risk due to policy intervention from Central Banks artificially suppressing yields and equity volatility. This could all change in 2017

The most probable scenario is a rally off 41.88 support, although I would not rule out a test of 35.84 - either way, I am looking to use crude as an indicator for the reflation/deflation theme over a 9-12 month horizon. I believe that the reflation theme remains valid, but will be challenged by a break below $42, and possibly reversed (deflation) below $36 longer-term.

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