Oil Turnabout Lower Has Negative Spillover For Other Markets - Analysis

The turnabout lower in oil prices Tuesday has had negative spillover effects for other instruments, with U.S. stock prices falling and U.S. Treasuries back in hot demand.

Risk appetite has improved in the past month mainly because of the notion of OPEC and non-OPEC members agreeing to either modest production cuts or at least a freeze in production.

The original soundbite about production cuts sent West Texas Intermediate flying higher, with the front contract posting a high of $34.82 on Jan. 28.

Subsequent commentary, initially refuting such an agreement and then pointing to consensus for a freeze in production at January levels, led oil prices first lower, to the near thirteen-year low of $26.05 seen Feb. 11, then higher, to a high of $33.34 Tuesday.

Today's oil bubble was burst by Saudi oil minister HE Ali-Al-Naimi, who did not offer the kind of supportive comments that the market anticipated.

Al Naimi, speaking as part of a panel discussion at the IHS Energy CERAWeek conference taking place Feb. 22-26 in Houston, Texas, said there was "no sense in wasting time" with production cuts, given the the lack of trust among producers.

"They will not happen; we are not banking on cuts," he said.

Al Naimi maintained instead that a freeze in production is more likely, adding that most countries will agree to a freeze.

Al Naimi argued in favor of a "minimum of meddling" with regard to oil markets, but also stated that participants should try to take action to limit a down cycle.

On accusations to the contrary, often in the media, Saudi Arabia, is "not chasing a greater market share," he stressed.

Oil prices slipped steadily in response to Al Naimi's remarks, with the downtrend picking up steam once it was clear that actual production cuts were completely off the table.

Asked when the oil crisis will be over, the Saudi oil minister said, "It's going to end; when I don't know."

NYMEX April light sweet crude oil futures were trading down $1.55 at $31.84 per barrel, on the low side of a $31.63 to $33.53 range.

The front contract has taken out support at $32.05/$31.98, which were Monday and Friday's peak, and a sub $32 close would suggest scope for a move back towards the psychological $30 mark. West Texas Intermediate posted a low of $29.48 Monday.

Earlier, WTI tested its 55-day moving average, currently at $33.16, but there was no sustained topside followthrough.

The next level of resistance is $33.60, the Feb 4 high, followed by highs at $34.18 and $34.40 (from Feb 1, Jan 29).

The real test will be whether WTI can vault the Jan 28 high of $34.82. Followthrough above $35 will be needed for upward momentum to mount.

Traders remained largely pessimistic about oil and still favor selling rallies, whether to $35 or $40, doubtful of a real change in fundamentals.

"The inventory overhang, which continues to build and usually rises into May on a seasonal basis, remains a major impediment to a sustained move up in crude oil prices," said Bob Sinche, global strategist at Amherst Pierpont.

"In this context, it appears crude oil prices, while likely establishing a double-bottom earlier this month, could remain quite volatile in a $26 - $35 trading range during the weeks ahead," he said.

As for the oil price effect on other markets, global investors fretted negative spillover on overall risk sentiment.

"Oil has been driving risk assets, and this unusually high correlation between oil and risk assets may continue as long as oil prices are below the threshold of around $40 a barrel, I'm guessing," said Stephen Jen, managing partner at SLJ Macro.

"Below $40, it seems that the tail risks associated with the spill over effects from problems in this sector rise exponentially, whereas above $40 there would be the more normal and traditional relationships between oil, the real economy, and the financial markets," he said.

Going forward, a larger "rally in oil prices, triggered by the supply side, could have a positive effect on energy and bank stocks," Jen said.

As for other markets, equities may be oversold in the near-term and poised for "a technical bounce," he said.

Nevertheless, Jen remained doubtful that a larger, more sustained stock rally would be seen in coming months.

"I continue to believe we are in a sell-on-rally phase, as equities will likely trade lower from here over time," he said.

The S&P 500 was trading down 0.98% at 1,926 Tuesday afternoon, on the low side of a 1,922.32 to 1,942.38 range, with the index retracing the bulk of Monday's 1.45% gains.

Monday saw the fourth day of a 1,900-plus close in the S&P.

As a reminder, the S&P 500 posted nearly a two-year low of 1,810.10 Feb. 11, taking out the prior 2016 low of 1,812.29, posted Jan. 20, with these levels viewed as double-bottom support.

A break below 1,800 would likely lead to large-scale stock selling. For EQ bulls to re-emerge, at minimum, the twin peaks of 1,947.20, seen Feb. 1 and 1,950.33, seen Jan. 13, must be vaulted decisively. The S&P 500 posted a high of 1,946.70 Monday.

Ten-year U.S Treasury yields were last at 1.739%, on the low side of a 1.719% to 1.812% range, with Treasuries firming as risk appetite waned.