Oil prices gain ground despite increased supply and stronger USD

There is widespread belief that a production freeze on crude oil will take place, spearheaded by major producers Russia and Saudi Arabia. Investor sentiment diminished somewhat on the latest news of an increase in operational US oil rigs. Oil prices tend to move in the opposite direction to increased supplies.
Brent crude oil futures touched $51.22 per barrel on the ICE exchange. By the close of the trading session, the price of Brent crude oil was $50.88. Brent crude oil futures managed gains of 8.32% for the week ending Friday, August 19, up $3.91 per barrel. This was also the strongest gain in a week since the beginning of April. Crude oil futures on the Nymex for September delivery ended $0.30 up at $48.52 a barrel. Since the lows recorded on Tuesday, 2 August, crude oil futures have gained approximately $10 per barrel, or 25%. What is driving the crude oil rally is the expectation that the upcoming meeting with Saudi Arabia will lead to decreased output.
An informal meeting between OPEC members is slated to take place in Algeria in September. This was announced by the Saudi Arabian Energy Minister in early August. What made the rally all the more impressive was the announcement by Russia that it too would be willing to freeze production. Nonetheless, the overall opinion is that nothing substantial will come from the talks. Recall that a meeting earlier in the year was upended when Iran did not commit to a production freeze. As a result, Saudi Arabia refused to commit to a production freeze.
The strong gains in oil futures are at odds with the realities on the ground. High inventory levels of crude oil and fuel products in the US, combined with an uptick in the number rigs in operation has put a damper on price increases. In other words, we are likely to see both WTI and Brent trading in a tight range over the short-term. A breakout and rally is unlikely, given the excess supply in markets. Baker Hughes reported that the number of operational oil rigs in the US has increased once again (the eighth successive rise) to 406. This is also the 11th successive increase over the past 12 weeks. The problem with an increasing oil price is that it acts as an incentive to other WTI crude oil producers to start drilling.

How are markets performing?
Oil prices propelled an energy stock boom in August, but the slowdown has affected markets. It is interesting that Brent remains in clear bull market territory with gains of 20% in August alone. This is driven by talk of a production freeze among key OPEC countries. Over the past year to August 19, there has been virtually no change in the price of Brent. Oil tumbled from over $50 a barrel to under $30 per barrel by January 2016. Then a period of consolidation in the oil price took place. Gold demand decreased with a stronger USD and increasing yields on government bonds. By Friday, August 19, the precious metal was trading $11 lower per ounce at $1,340. For the week, gold was up $5.
The Dow Jones Industrial Average was 0.24% lower at 18,552.57, and the S&P 500 was 0.14% lower at 2,183.87. The NASDAQ Composite Index was 0.03% lower at 5,238.38 and the NYSE Composite Index was 0.31% lower at 10,829.15, down 0.31%. Across the Atlantic, the Euro Stoxx 50 PR was 0.90% lower at 2,968.20, the FTSE 100 was 0.15% lower at 6,858.95 and the DAX was down 0.55% at 10,544.36. The French CAC 40 was down 0.82% at 4,400.52 and the IBEX was down 1.16% at 8,450.60. In Asia, the Nikkei 225 was 0.22% higher at 16,582.85 and the CSI 300 was 0.64% lower at 3,343.61.
US Fed Vice Chairman Stanley Fischer indicated that a rate hike in 2016 is still being discussed. According to Fischer, the US economy is fast approaching the goals set forth by the central bank. The speech was showcased at the Aspen Institute in Colorado on Sunday. Fischer expects that growth targets will be reached, notably GDP growth. One of the major concerns is investment. Fischer anticipates that as the ‘lag effect’ from dollar appreciation declines, GDP growth will gain momentum. This statement from Stanley Fischer is important, given that Fed Chair Janet Yellen will be speaking on August 26 at Jackson Hole, Wyoming. Investors across the board are searching for clues about the scope and timing of the next Fed rate hike.
The expectation is that the Jackson Hole meeting will be more of the same, with Yellen perhaps echoing the sentiments of Fischer. GDP has been somewhat disappointing as the Fed has moved towards its 2% target for inflation. US core prices are gradually rising and most analysts expect that inflation will hit the 2% target over the medium-term. Some of the notable declines in the economy include a dramatic change to productivity growth at 1.25%. If the slowdown persists, then wage growth, employment prospects and economic policy would be adversely affected. But in Fischer’s opinion, it is not the job of monetary policy to increase productivity. He is of the opinion that regulation and fiscal policy can improve the output per hour. The areas that Fischer pointed out include improved education, public infrastructure and private investment.

Policy measures adopted by the Fed
In December 2015, the Fed raised the federal funds rate (FFR) 0.25-0.50%. Since then, there have been calls for several rate hikes in 2016. According to the CME FedWatch Tool, the likelihood of a September 21 rate hike is negligible. The odds of rates hitting 0.50-0.75% are 12% and the likelihood of rates staying at the currency level are 88%. As we move forward, the likelihood of rates staying in the 0.25-0.50% range are 80.7%, and for rates to rise to 0.50-0.75% is 18.3%. The likelihood of rates rising above that to 0.75-1% are at a minimal 1%. The final Fed FOMC meeting takes place on December 14. There is a 53.8% likelihood of rates remaining at the current level, a 39.1% chance of rates rising by 0.25% to 2.50% as 0.75%, and a 6.8% chance of interest rates rising further to 0.75% – 1%. Just 0.3% of participants anticipate the interest-rate hike to yield a federal funds rate of 1% – 1.25%.