Oil (CL1:COM) could be sending a chilling message about the state of the global economy as it sinks to a critical level of support that dates back to the winter of 2018. Oil’s recent weakness isn’t going unnoticed because US bond yields have been falling in sympathy with the declining prices.
Of course, this makes oil’s current positioning on a level of technical support that goes back years all the more important. One could argue that a decline below support in the $65/barrel region could significantly decrease prices, resulting in rates falling further and potentially signalling a severe global slowdown.
The decline in oil prices could be largely due to China’s weakness, which has seen its 10-year rate fall to new all-time lows. While Oil and the 10-year rate in China haven’t tracked each other over time, both seem to have traded more in line recently.
Bloomberg
The weakening sentiment in China appears to be playing a role in the outlook for oil demand, at least on the surface. But where oil goes may be more telling of whether the weakness in oil can spill over to the rest of the world.
The region around $65 for crude oil has been at a fundamental level, which has acted as both support and resistance over the years. Before the pandemic, it acted as a level of resistance on a couple of occasions in 2019 and 2020, and post-pandemic, it has acted as support a few times throughout 2023 and part of 2024. Clearly, if oil were to breach this region of support, it would suggest that something is off with global growth, perhaps stemming from China.
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Oil prices have also been making a series of lower highs, which suggests a firm downtrend is currently in place. This could also suggest a descending triangle has formed, a pattern that generally results in a break lower and below support. A break of such an important level of support could lead to the price falling to around $52 and perhaps even lower over the longer term to about $45.
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But there is a reason why this reason has acted as support for such a long time, and just because the pattern suggests that oil breaks lower doesn’t mean it will. If support holds for one more time, it probably suggests oil rallies back to the downtrend at $79.
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But clearly, a break below support would carry a more significant and overarching message because it would be sending a very clear and loud signal about the state of the global economy. It would likely lead to rates in the US continuing to decline, which would also affect FX pairs, and probably the Japanese yen, the most, and allow it to continue to strengthen.
The spreads between US and Japanese 10-year rates have continued to contract recently, which has been a determining factor in the yen’s strengthening versus the dollar.
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The yen has already strengthened to around 140.60 versus the dollar (USD:JPY), and like oil, it finds itself at support. A break of support could lead to the yen strengthening to around 137.60 versus the dollar.
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A strong yen, a steeper yield curve, and weaker oil prices would send a pretty chilling warning about the state of the global economy that should be considered when assessing the current macro landscape. If oil breaks that multi-year support level, it will probably have much further to drop.
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