Energy Is Now Viewed as the Next Fault Line for Global Markets

© Reuters. Energy Is Now Viewed as the Next Fault Line for Global Markets

(Bloomberg) -- This year’s standout inflation trade of backing commodities is coming under pressure on concern a recession will curb demand for raw materials.

That’s the view of Mandy Xu, head of equity derivatives strategy at Credit Suisse Group AG, who said derivatives-market bets for crude show growing speculation that the deteriorating economic outlook may outweigh supply challenges.

“Even the most supply constrained commodity such as oil, what we’ve started to see in the derivatives market is people starting to price in more downside risk,” Xu said in a Bloomberg Television interview.

Xu cited a measure from the options market known as the put skew, the premium a buyer must pay to protect against a decline in prices versus a rise. She said the climbing skew signals worries about downside risks to global growth.

Everything from industrial metals to crude oil has tumbled this month, pushing down a gauge of commodities to the lowest level since March. Fears that tightening US monetary policy will lead to a recession are gripping global markets, overshadowing supply challenges facing raw materials.

“The only sector up on the year is energy and that is what we’ve been highlighting for a couple of weeks now in terms of the next potential pain point for investors,” Xu said. “The risk of recession means that further upside in the sector is likely limited.”

The energy sector in the S&P 500 is up 32% this year, the only subgroup of the index still in the green. But a wider debate is now raging about the outlook for oil prices. Goldman Sachs Group Inc (NYSE:GS). said in a note on Tuesday that demand is still running ahead of supply, warning the Fed “cannot print commodities.” 

Weaker Demand

Others are more bearish.

“A declining price profile across most mining and energy commodities is justified in light of a weakening demand outlook,” said Vivek Dhar, a commodities analyst at Commonwealth Bank of Australia (OTC:CMWAY). 

The outlook for rising prices “is likely contingent on China relaxing its Covid‑zero policy,” he wrote in a note Thursday, referring to Beijing’s preference for mobility curbs to stamp out virus outbreaks.

That path ahead for raw-material prices is crucial to global markets. Sustained declines may help curb inflation expectations and allow central banks to slow the pace of interest-rate hikes, potentially bolstering stocks and bonds.

“Falling commodities should be welcomed, as it breeds disinflationary pressures,” Chris Weston, head of research at Pepperstone Group, wrote in a note. “This dynamic becomes far more bullish for equities if it’s driven by the perception of rising supply, not demand concerns, which seems to be the case now.”

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