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Following OPEC+ meeting, can oil serve as a hedge against inflation and recession?

Jovi Ho
Jovi Ho8/8/2022 09:00 AM GMT+08  • 6 min read
Following OPEC+ meeting, can oil serve as a hedge against inflation and recession?
“The outlook has darkened significantly since April. The world may soon be teetering on the edge of a global recession.”
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The world’s oil-exporting countries have agreed to a small increase in oil production quotas for September, equivalent to 0.1% of global oil demand, amid tight production capacity.

The Organization of the Oil Exporting Countries and its allies, also known as OPEC+, announced on Aug 3 that it would produce an additional 100,000 barrels of oil a day in September. OPEC+ is scheduled to meet again on Sept 5.

This is the latest increase since June, when OPEC+ upped output by 648,000 barrels per day for July and August, up from the previous quota of 432,000 barrels per day. The new quota comes after US president Joe Biden urged major oil producing states to increase oil production during a visit to the Middle East in July.

Cost pressures

Consumers and businesses across the world from both emerging and developed economies alike are facing their heftiest increase in cost pressure in decades. Biden’s plea for increased oil production was just one of the US’ attempts at stemming price increases.

In a bid to curb inflation from getting further out of hand, US Federal Reserve on July 28 raised Fed fund rates by 75 basis points (bps) for the second straight month to between 2.25% and 2.5%, while signalling that a third hike could be possible in September.

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FedWatch Tool calculates the probabilities of a range of Fed actions, from rate hikes to upcoming Federal Open Market Committee (FOMC) meetings. It also features a countdown timer to the next FOMC meeting, due on September 20.

The Fed’s rate hike came just days after the International Monetary Fund (IMF) cut its global growth outlook for this year and next, owing to central banks’ interest rate increases to stem inflation.

According to the IMF, global GDP may slow to 3.2% this year, less than the 3.6% forecast by the fund in April and the 4.4% seen in January.

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“The outlook has darkened significantly since April. The world may soon be teetering on the edge of a global recession, only two years after the last one,” says Pierre-Olivier Gourinchas, the IMF’s chief economist.

Managing inflation expectations

The rush to cool prices originates from a paradigm shift for central banks, says Selena Ling, chief economist at OCBC Bank. “What has changed for the central banks is that they are no longer just talking about combating inflation, but they're talking about the risk of what they call anchoring of inflationary expectations.”

So sensitive is the market today that hawkish sentiment alone could be more damaging than the actual rate hikes. “It's not about just fighting inflation alone; central banks actually need to manage expectations,” says Ling, who is also head of treasury research & strategy at OCBC.

Still, Ling acknowledges some market relief that the Fed had hiked 75 bps instead of a full percentage point. “But this does not mean that the Fed is pausing its rate hike trajectory anytime soon. So, there is a need to watch if the overnight or current risk rally can sustain.”

As central banks impose larger hikes, the risk of a policy mistake increases correspondingly. “If they front-load aggressively, even when growth is slowing down, the risk is that they really drive the economy into an actual recession,” says Ling.

Here, Ling differs from the IMF’s harbingering. “Our baseline [forecast] is that we won’t have a global growth recession this year, but we will see brief and shallow recessions in parts of the world.”

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OCBC forecasts 1.7% GDP growth for the US in 2022, far below the UK’s 3.6%, China’s 4.8%, Malaysia’s 5.7% and Singapore’s 3.8%.

With the US inflation at its highest in four decades, Ling thinks the Fed is likely to stay the course. “The Fed is still obsessed with combating inflation and also anchoring inflationary expectations. So, barring any quick stabilisation in the inflation readings, it is unlikely that market players may be reading too much into the Fed tea leaves that they are turning more dovish.”

Alternatives to the stock market

With the prospects of slowing economies becoming real, markets have corrected significantly thus far this year. Savvier traders are able to take advantage of the volatility but the majority of investors are more concerned with looking for asset classes offering shelter.

Cash is perhaps the most vulnerable asset, with rising inflation constantly eroding the value of fiat currency. Equities and ETFs may be perennial favourites, but their underlying assets are also at the mercy of macroeconomic sentiment — as are their share prices.

Which investment tools can be used to mitigate risks directly, independent of market sentiment?

Gold may have run its course over the past year but Ling is “less constructive” on the bullion as an inflation hedge now. “We expect that central banks will continue to be hawkish in the short-term. For gold, which is a non-yielding asset, the differential is quite big right now. It actually doesn’t look that attractive in the current environment.”

With commodities in short supply and an energy crunch owing to the Russia-Ukraine war, could oil be a viable investment in the remainder of the year? Oil futures, for example, allow investors to trade rising and falling prices.

OPEC Watch Tool had predicted with 99.13% probability that the OPEC+ would maintain an increase in output at the Aug 3 meeting, overwhelming the two other possibilities of a further output increase or a small output decrease.

The free web tool uses the New York Mercantile Exchange (NYMEX) West Texas Intermediate (WTI) crude oil option price to calculate the probabilities of certain outcomes from the nearest weekly and monthly options that expire around OPEC’s meetings.

US crude oil futures sank below US$91 per barrel on Aug 3 in anticipation of the meeting, down from some US$96 a day prior. Year-to-date, however, crude oil futures have gained 26%, with a spike to some US$123 in March following Russia’s invasion of Ukraine. Following the meeting, WTI crude oil futures are still below US$91 as of Aug 4.

Oil prices have historically slid with the threat of a recession. Paired with the ongoing war, however, prices could remain volatile. Oil could present an opportunity for range trading, says Ling, but she warns of “potentially wide swings”.

Ling adds: “If global demand really moderates with growing recession fears for many major economies — such as the US and Germany — and hard landing concerns for China, then there could be a tug-of-war with the supply concerns arising from the Russia-Ukraine war.”

With this less than cheery economic prognosis, how can investors position themselves? Ultimately, sitting still and holding cash will only result in their own spending power getting undermined by inflation.

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