Chinese rate increase shows oil fragility

Shanghai Surprise

A whole new ball game! Did China's surprise interest rate increase rebalance what seemed to be an out of balance global economy? Will this interest rate increase take the heat off the Chinese who are under increasing U.S. pressure to set their currency free? China crushed the runaway commodity complex when it raised its benchmark deposit and lending rates by 0.25 percentage point yesterday for the first time since December 2007.

The move was to stem domestic inflation, but it could be the first of a series of rate increases that could also be seen as a move gesturing to the United States for our restraint by not declaring them a currency manipulator. In the real world a currency that is allowed to float would normally increase the value of its currency. For the Chinese, by raising interest rates, it was almost like a de facto increase in the value of their currency. By doing that, it raised worries that even a slight slowing in the Chinese economy could slow the growth of neighbors and the uncertainty surrounding their next move improved the value of our beaten down greenback. It also reduced the price of commodities that threatened to derail the global economic recovery.

We all know that the United States is pressuring China to increase the value on their yuan and that commodities have soared since the Federal Reserve at their Sept. 23 meeting said that they promised to provide additional accommodation if needed to support the economic recovery and to return inflation over time. Yet after China took steps to put the brakes on the economy, we saw how fragile that artificially inspired oil and commodity rally really was.

The prices of oil and gold first and foremost have been a product of massive government intervention designed to take away the illusion of deflation. When oil surged and broke up into the mid-eighties, we heard a slew of predictions touting the second coming of $100 barrel oil. Analysts were seizing on short term data that seemed to suggest the global supplies were tightening. While many had designs on sharply higher oil prices, we see how quickly global central banks can change the equation.

China's bustling, explosive economy was also helped along by massive government stimulus, a stimulus that had to be removed. As the Chinese economy rebounds, the Chinese government is acutely aware of the fact that they have created a bit of a bubble. Maybe a massive bubble. If they do not slow down growth and manage their soaring inflation surge, they risk bursting that bubble. At the same time the possibility of a currency war or a trade war is the type of disruption that could make trying to manage this wild lion of an economy absolutely impossible.

More mundanely, if the Chinese continue to raise rates, demand for commodities will fall. For oil that means that we are still in a range, the same range that we have been in for most of the year. We have said time and time again that oil, if based on fundamentals of supply and demand, should be substantially lower, but all of the printing of money is keeping the market supported. While many long for the days when oil added to its price year after year, the truth is that once again there is a real chance that oil will end the year lower than where we started.

Maybe supply might matter today. The American Petroleum Institute reported that crude inventories rose by 2.315 million barrels. Gasoline inventories fell by 83,000 barrels, while distillate stocks dropped by 854,000 barrels. Refinery runs rose to 80.9% from a revised figure of 80.3% last week.

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com.

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.

 

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