Oil can reach $100; what does it mean for markets and inflation?

Oil can reach $100; what does it mean for markets and inflation?

2022-02-21 • Updated

More and more analysts are sure Brent oil will surpass $100 a barrel. Some of them forecast that $125 and $150 levels will be reached over several months. As oil is one of the most (if not the most) traded commodities in the world, it can't help but impact inflation and financial markets. At least, people think so. So how heavily will oil move the markets, and what will the direction of the movement be? Let's find out!

The correlation of oil and stock market

 An increase in oil prices usually lowers the expected economic growth rate and increases inflation expectations over shorter horizons. Decreasing economic growth prospects, in turn, reduces companies' earnings expectations, resulting in a dampening effect on stock prices. But that's in theory. So let's look at the correlation meter to find out the truth.

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Here you can see S&P500 (US500) index (orange) compared with XBR/USD (UK Brent oil, blue). In addition, you can find a correlation meter at the bottom of the screen, a tool to measure the correlation between instruments and assets. It is evident that since the crash in March 2020, both US500 and XBR/USD have had a positive correlation. It is opposite to the market expectations of oil and stock price movement and shows that high oil prices don't always mean a slump in stocks.

The truth about oil

We searched the web and found out that researchers at the Federal Reserve Bank of Cleveland looked at movements in the price of oil and stock market prices and discovered that there is little correlation between oil prices and the stock market.

Also, it would be best if you separate correlation and causation. Oil does impact the US economy, but this impact is bidirectional. On the one hand, high oil prices create more jobs in the oil industry and increase investments in shale oil deposits. On the other hand, high oil prices also hit businesses and consumers with higher transportation and manufacturing costs. To be more specific, we can assume that change in oil prices causes money transfer from energy-consuming companies to oil production and vice versa. Oil doesn't drive stock prices because other price factors in the economy—such as wages, interest rates, industrial metals, plastic, and computer technology—can offset changes in energy costs.

In other words, the economy is too complex to expect one commodity to drive all business activity in a predictable way.

What to expect now?

Technically, oil is in a consolidation. A breakout of the $93.00 level will turn on the bullish scenario. However, considering the negative correlation with US500 at the present moment, the latter may decrease even more. The oil may move higher to the resistance of $91.00 per barrel in the short term.

XBR/USD H4 chart

Resistance: 91.00, 93.00, 95.00;

Support: 88.00, 86.00, 81.00

  XBRUSDH4.png

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