Oil Is in Another Bear Market - and for Good Reason
West Texas Intermediate crude oil futures fell below $102 a barrel Wednesday, which represents a 22% drop over the past two weeks and meeting the technical definition of a bear market. It certainly doesn’t feel like a bear market, especially since crude is still up about 40% this year. And if you spend any time on Twitter, you know that oil and energy stocks have some very enthusiastic supporters, most of whom predict oil will rise to $200 a barrel. In fact, call options with a $200 strike price have traded rather briskly in recent weeks.
Most of the bull case in oil revolves around the twin theses of government incompetence and socially responsible, or ESG, investing, both of which are restricting drilling and raising the cost of capital for oil producers, thereby reducing supply. Now, the government is mulling a gasoline tax holiday and even issuing gas rebate cards, both of which represent a direct subsidy of demand. Every first-year economic student knows that if you increase the demand of a thing and reduce the supply of that thing, you are likely to increase the price of said thing. But that doesn’t explain the recent downturn in oil, and the oil bulls make no attempts at doing so.
So, what is the decline in oil prices all about? My guess is that it’s a reflection of the higher odds of a recession, and the resulting demand destruction. Oil tumbled as much as 8.24% on Wednesday, the most since early March, as Federal Reserve Chair Jerome Powell said a recession is possible and calling a soft landing “very challenging.” The drop in oil prices was accompanied by a big drop in bond yields. If the price of oil falls, so will inflation rates, as oil is a primary driver of inflation. And if that happens, the Fed won’t have to raise interest rates as much, resulting in lower bond yields. Stocks rallied as well, and the dollar weakened. The price of oil is driving all markets and the economy at the moment, and if oil prices go down, everything will get better.