Oil's Recovery Capped by Demand Downgrade

Crude oil recovered after a sharp selloff in Asian session yesterday amid the broad-based lift in sentiment on Fed's pledge to keep interest rates low at least until mid-2013. Prices, however, continued to struggle as the OPEC lowered demand growth forecasts, the EIA cut its oil price forecasts and Saudi Arabia maintained its oil output despite price declines. The front-month contract for WTI crude oil rebounded from as low as 75.71 and settled at 79.3, down -2.47, while the equivalent Brent crude contract ended the day at 102.57, down -1.13%, after initially plunging to 98.74.

Fed's August meeting statement was much more dovish than previous ones. Policymakers acknowledged that growth has been 'considerably slower' than expected. Indicators suggest 'a deterioration in overall labor market conditions in recent months'. More importantly, recent weakness should have been driven by pervasive factors because temporary factors including 'higher food and energy prices' and 'supply chain disruptions' associated with the earthquake in Japan' accounted for 'only some of the recent weakness in economic activity'. Inflation has 'moderated' as 'prices of energy and some commodities have declined from their earlier peaks'. The Fed expected that inflation will 'settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further'.

In light of more downside risks to the economic outlook, the Fed decided to keep the Fed funds rate at 'exceptionally low levels for the federal funds rate at least through mid-2013'. Meanwhile, the central bank will maintain its existing policy of reinvesting principal payments from its securities holdings and will regularly 'review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate'.

Although the Fed did not explicitly signal it will adopt QE3, the change of language in the 'extended period' phrase, maintenance of the reinvestment program, inflation expectations and discussion of 'the range of policy tools available to promote a stronger economic recovery in a context of price stability' indicated that the Fed will resume outright asset purchases, should economic outlook deteriorate further.

The OPEC cut its oil demand forecasts for 2011 and 2012 amid economic worries. The cartel expects oil demand to increase to 88.1M bpd, down -0.15M bpd from June's forecast, this year and then to 89.4M bpd, down around -0.1M bpd from June, in 2012. According to Reuters, the biggest oil producer Saudi Arabia will keep its supply to Europe and Asia unchanged in September despite recent slump in oil prices and worsening macroeconomic outlook. The DOE/EIA said in its Short-Term Energy Report that it reduced crude-oil price forecast to 95.71 for 2011 and 101 for 2012, down from corresponding forecasts of 98.43 and 102.5 made in June. The news capped oil's rebound compared with other assets.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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