If there is one market that deserves particular attention in 2021, that is oil. If one considers that a year ago, the price of the WTI crude oil settled below zero, close to -$40, the comeback is even more impressive.
Crude oil price traded close to $68 this week, in a bullish trend that marks the best start of a trading year in at least three decades. Oil is inflationary; every trader knows that, but the pace of the recent move is so aggressive that one is wondering how sustainable inflation will be for the overall economic recovery?
What Stands Behind Higher Oil Prices?
For FX traders, the rise in the price of oil is even more concerning. To exemplify, think of the fact that all central banks in the developed world have an inflation target within their mandate. Because oil is inflationary, central banks expect higher inflation when the prices of oil rise and lower when the opposite happens. Yet, they also view inflation generated by higher oil prices as temporary. The problem is that as long as the prices of oil keep rising, the “temporary” factor extends. So, what to do – to let inflation run or not? What if the prices of oil keep climbing for the rest of the year and even beyond?
One reason behind the bullish trend in the WTI crude oil price is, obviously, the success of the vaccination campaign. More precisely, the expected success, as indicated by the slowdown in infection rates and hospitalizations in countries that vaccinated a big part of their population.
This triggered expectations of “back to normal”, so demand levels increased. However, the supply side is not matching the rise in demand for the simple reason that the oil-producing countries keep holding on to their production cut levels.
Second, the restrained supply was further accentuated by a recent attack on three main oil terminals in Saudi Arabia. Disruptions to Saudi output will threaten the supply chain even more – so the WTI crude oil price made another new higher high on the charts.
Finally, the U.S. fiscal stimulus. America announced a new round of fiscal stimulus, $1.9 trillion, despite strong evidence that the economy is picking up. Because America is the world’s largest oil consumer and the largest economy in the world, the stimulus will lead to a higher growth perspective for the rest of the world. Hence, even stronger oil demand on tight supplies.
Economics 101 tells us that when demand exceeds supply, the price increases. As long as the balance does not change, higher prices may have more room to go.