Oil: Welcome to the next leg lower

The Oil markets officially entered the next leg lower yesterday, with Brent spiraling down to $52.64 and Crude crashing below $50 at $49.67. The economic conditions that oil faces continue to be aggressively against the commodity, making buyers extremely hesitant to even consider entering long positions. For example, all indications continue to point towards there still being an oversupply in the markets and these views would have strengthened further following the recent reports that both Iraq and Russia increased production. In addition, global economic concerns remain and they are not likely to die down anytime soon.

The problem with the global economic concerns is that they may result in even less demand for oil, which as a result is also inspiring investors to jump on the selling wagon. For example, it was recently announced from China (the largest consumer of oil) that its Manufacturing PMI for December had declined to a 2014 low, and in the days following this, aggressive selling in the oil markets has resumed. This is not a coincidence. Economic concerns over a large consumer of oil, like China is going to lead to fears there will be even less demand for the commodity, which in turn will further elevate anxiety about an oversupply. There are also suspicions that as oil companies struggle to adapt to lower profits, there could be mergers and acquisitions taking place in the future and this will weigh on investor sentiment. What’s the answer to this equation? Bearish moves for oil.

As we enter trading on Tuesday morning, global indices are pointing to the downside. This is not a surprise considering the drop in oil prices yesterday. Global economic concerns are also possibly weighing on the performance of indices, which will be further emphasized if Europe’s Services PMI later this morning reaffirms the need for Mario Draghi to pull out more tools from the stimulus toolbox. If the pressure on global indices continues, it’s also possible that the pressure will weigh on the USD at some point. The Federal Reserve can prevent this though, with a hawkish comment in Wednesday’s highly anticipated FOMC Minutes, and if Friday’s NFP reconfirms the expectations for the Fed to begin raising interest rates in the coming months.

As we have seen when global indices previously pointed to the downside in both October and December, investors become attracted to the JPY and we are already beginning to see this on Tuesday morning. The USDJPY has pulled back by close to 200 pips since Monday’s high (120.639) and similar moves are being noticed in other JPY pairs, such as the EURJPY and GBPJPY.

The Pound will also be at risk today, depending on how the markets react to the UK Services PMI for December. Considering the Services sector constitutes the UK’s largest GDP contributor, this is a critical indicator to find out how the UK economy concluded 2014. The previous two days Construction and Manufacturing PMI have pointed towards more signs of a domestic slowdown, and this alongside headlines beginning to focus on the upcoming May General Election has largely contributed towards a drop of close to 400 pips in the GBPUSD since Friday.

Written by Jameel Ahmad, Chief Market Analyst at FXTM.

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