Oil price takes a breather, as we wait for CPI

It’s the end of an eventful week, and we’re not over yet. So far, markets are stabilizing, and reversing some of Thursday’s extreme moves in the oil price and in bonds. Stocks are also recovering as we approach the end of the week. Below, we look at four developments to watch on Friday.

• The oil price is down 3% so far on Friday, and Brent crude is trading around $104 per barrel. It is still up 8% this week, and energy prices remain elevated and too high for comfort. However, the pullback in the oil price could be some anticipation that a last minute deal/ ceasefire could be made between the US and Iran over the weekend. This is the only development that could stave off a rate hike from the Federal Reserve next week, in our view. Gas prices in Europe have also partly reversed last week’s move, although petrol prices in the UK remain at a 4-year high, and diesel prices in the US are at a record.
• The bond market is also stabilising. Yields are dropping sharply in the UK, Europe and the US. The Gilt market is one of the top performers on Friday, and yields are falling at a quicker pace than elsewhere. The 2-year yield is down 6bps today with smaller declines at the long end of the curve. However, this only partly reverses the 16bp increase in 2-year Gilt yields on Thursday. There have been no fresh developments in the Middle East overnight, as long as this continues then global bond yields may moderate from here, although we expect yields to remain elevated in the longer term as energy supplies remain constrained.
• The UK economy surprised to the upside in July. Analysts had expected flat growth for July, but the economy actually expanded by 0.4%. This was driven by one-off factors like the World Cup and hot weather leading to a mini boom in staycations. However, the big driver of growth was AI. It appears that the UK economy will finally reap the benefits from being the third largest AI market in the world. Services rose by 0.6% in the three months to July, and this was driven by an AI uplift. Computer programming, consultancy and IT grew by more than 3%, and the ONS said that increased commercial spending on AI, including on data centres, and software implementation were core to economic growth. This could be a long-term tailwind for the UK economy, the question is, can it neutralise the effects of an energy price spike and the bond market turmoil? Overall, the stronger GDP does help build the case for BOE hawks to raise interest rates, but the BOE seems more concerned about the labour market right now. The stronger GDP data is having an ameliorating effect on the UK bond market. When you are indebted like the UK, you need growing amounts of revenue to entice investors and show that you can pay back what you have borrowed. So, ironically, strong growth could help yields fall in the UK.
• The CPI report in the US is the key macro event for today, and it could decide if the Fed hikes rates next week. Currently there is a 67% chance of a hike, down from 71% on Thursday. The market expects headline CPI to remain at 3.4% for August, and core prices to fall a notch to 2.4%. Overall, a backwards CPI report is less important for financial markets today than real-time movements in the oil price, so if CPI comes in roughly inline with expectations, market moves could be limited.

Chart 1: The oil price is higher by 8% this week

Source: XTB

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