Oil hanging on U.S. and EU debt talks

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The word debt played a major role in yesterday's action in both the financial and commodity markets and that word has carried through the overnight trading session and into this morning as well. The big boost came mid-day when a bipartisan group in the US Senate revitalized a debt plan that is now starting to get legs all the way through to the President. The markets picked up on the talk as a sign that the US politicians may be able to put together a debt and deficit ceiling deal by the August 2 date when the US government is supposedly going to hit its legal limit. The next few days will be critical to see if there is enough support in the Senate to pass a bill and then if the US House of Representatives will go along with the plan. Irrespective of one's view of what a plan should look like the markets are clearly saying they want to see a plan to raise the debt ceiling and not a default as demonstrated by the positive reaction in the markets from yesterday's lose comments concerning the Senate initiative under way.

On the other side of the Atlantic the evolving sovereign debt problems are starting to look more and more like a resolution may be forming as the EU leaders get ready for their summit on Thursday. The EU leaders need to come up with a plan to avoid a contagion to other southern EU member countries like Italy and Spain. The markets are starting to view a solution from the EU as a bit more likely with many old and some new options now on the table for the meeting.

Much like the US problem the markets want a resolution and not a default as even an imperfect resolution to both the US and EU debt problems will be better than a default (from the markets perspective) which is likely to result in a chaotic situation much like what occurred when Lehman Brothers collapsed in 2008. I do not think the politicians and leaders in both of these regions want a default either and as such I still believe there will be an agreement of some sorts in both the US and the EU.

How the markets ultimately react to a solution is still a bit of an unknown. Right now any signs that an agreement has been reached in the EU and the US will result in a short covering rally in global equities with at least some follow through into many of the commodity markets like oil. How sustainable this move could be will be directly dependent on how much of the agreements are smoke and mirrors type solutions or actual deep rooted solutions to the debt exposure in both the US and EU. That we will have to wait and see how it evolves over the next several days. But a global equity rally is certainly a positive for oil prices.

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