Oil Market Approaches Critical Level Amid Geopolitical Tensions

Job growth has slowed, raising concerns about reduced economic activity and oil demand. However, employment in cyclical sectors remains strong, indicating no immediate signs of a recession. Despite declining trends in manufacturing and services PMI, record U.S. oil production has kept crude prices lower with potential for a rebound.

China’s weak industrial demand and trade barriers could further impact global economics. This article examines recent economic indicators affecting the oil market and provides a technical analysis of Brent crude oil prices to determine the future direction of the oil market. It has been found that Brent crude oil has approached a critical level and is poised for a rebound or a breakout.

Economic Trends and Impact on the Oil Market

The chart below presents the total nonfarm payrolls, showing job growth slowing to 114 thousand in July. This week’s July labor report highlights the Fed’s stance on early rate cuts, impacting the financial markets. A slowdown in job growth and potential rate cuts could lead to lower economic activity, potentially reducing demand for oil and putting downward pressure on oil prices.

On the other hand, the chart below shows that employment in cyclical sectors such as manufacturing, construction, and transport & warehousing grew by over 27,000 jobs in July. This growth indicates that there are no signs of a recession.

The Sahm Recession Indicator is a valuable economic tool that signals the onset of a recession. It operates by monitoring the three-month moving average of the national unemployment rate, known as U3. Specifically, it indicates a recession when this average increases by 0.50 percentage points or more compared to the lowest three-month average recorded in the preceding 12 months.

The chart below illustrates that the Sahm Recession indicator has recently surpassed the 0.50 percentage point threshold. Typically, this breach would suggest that a recession is imminent. However, it is important to note that the current rise in the unemployment rate is starting from an exceptionally low base level. Therefore, this instance might represent an anomaly, implying that the traditional interpretation of the indicator may not apply as it usually does.

On the other hand, the ISM manufacturing and services PMI has shown a declining trend over the past two years, as illustrated in the chart below. This declining trend indicates slower growth. The ISM services PMI increased to 51.50%, which is above the 50% threshold, indicating expansion. Meanwhile, the manufacturing PMI decreased to 46.8%, but it remains above the 42.5% threshold. This threshold typically leads to a recession. Currently, the 46.8% is well above the recession threshold value, but the declining trend still serves as a warning.

Geopolitical tensions in the Middle East have heightened fears regarding the stability of oil supplies from the region. However, these concerns have not significantly impacted crude prices, as the market is currently dominated by record U.S. crude oil production, which stands at 13.30 million barrels per day.

This level of production has been increasing since 2020 and remains elevated. The high production levels have led to an abundant supply of oil in the market, creating a surplus and putting downward pressure on prices. As a result, Brent crude oil prices have found strong support at the $75-$76 range and are poised for a potential rebound.

The U.S. Department of Energy is expected to maintain price levels by replenishing the Strategic Petroleum Reserve (SPR). If prices fall too low, there is a risk that production will decrease as producers may shut down less profitable wells.

Falling crude oil and base metal prices indicate weak industrial demand from China. As China attempts to offset this by exporting surplus production, it is expected to face significant resistance from trading partners. The imposition of additional trade barriers is anticipated to decelerate Chinese manufacturing further and reduce commodity imports, adversely affecting resource-based economies.

Crude Oil Prices Approaching Critical Level

The monthly chart for Brent crude oil shows that the price is approaching a key area of support where a strong rebound might develop. This key area of support, discussed in a previous article, indicates that the price remains within a symmetrical triangle, similar to the one formed from 2011 to 2014. Previously, a break below this symmetrical triangle led to a significant decline.

This time, a similar break could potentially target prices below $30. However, given the current economic conditions and geopolitical crises, the next direction of crude oil cannot be confirmed as the price continues to fluctuate and consolidate within the triangle. The peak at $139.13, followed by the formation of the symmetrical triangle suggests potential price weakness.

To further understand the outlook, the weekly chart below presents the formation of a triangle from October 2022 to August 2024. When the lower line of this triangle is extended to the March 2021 lows, it forms a neckline with the head and shoulder patterns. The head of this pattern is at the March 2022 high of $139.13, which also represents a double top at $139.13 and $125.19. The multiple red arcs on this chart present a bearish view, indicating that oil prices remain bearish.

The red circle highlights where the price currently fluctuates, showing strong support and suggesting a likely rebound in the short term. A break below this area may trigger a sharp drop in oil prices, initially targeting $60-$65. This pattern shows the bearish trend in oil prices for the long term, although a strong rebound is expected in the short term. Strong oil production is a key factor driving this bearish price pattern.

Final Thoughts

In conclusion, the current economic indicators present a mixed outlook for the U.S. economy. While job growth has slowed, raising concerns about reduced economic activity, the strength in cyclical sector employment suggests no immediate recession.

The Sahm Recession indicator’s recent threshold breach warrants caution, though it may not signal an imminent recession due to historically low unemployment rates. This could lead to fluctuating oil demand and prices, with potential short-term stability but long-term volatility in the oil market. Moreover, declining trends in manufacturing and services PMIs add to the cautious sentiment.

On the other hand, geopolitical tensions and China’s weak industrial demand further influence global economic dynamics. Despite these bearish signals, technical analysis shows that the price is approaching critical support in the short term and looks for a strong rebound. A break below $72 will break the symmetrical triangle and may initiate a downtrend, initially targeting the $65-$60 levels. Alternatively, a recovery above $92 will trigger a rally, targeting the $105-$110 range.