Hedge Funds’ Ultra-Bearish Oil Bets Signal US Recession Angst


Derivative traders engaged in oil and fuel price contracts are currently exhibiting a level of bearishness that hasn’t been seen in over a decade. This indicates their preparedness for a potential recession that could result in further declines for various contracts, ranging from crude oil to jet fuel, as reported by Yahoo.

Oil contracts

Non-commercial players, such as hedge funds, are displaying extremely bearish positions in major oil contracts, reaching levels not seen since at least 2011. Specifically, bets on diesel and gasoil, which are key indicators of economic activity, are at their most bearish since the early days of the Covid-19 pandemic. Multiple factors contribute to the pessimism in the oil market, including concerns over potential economic contraction due to Federal Reserve rate hikes, China’s slow recovery from Covid-19 restrictions, the risk of a US default if the debt ceiling is not raised, and uncertainties surrounding OPEC+’s ability to fulfil promised output cuts. Industry experts find the level of bearish positioning to be noteworthy and indicative of the prevailing market sentiment.

Pandemic savings 

While non-commercial investors in the oil market exhibit bearish positions, it is important to note that they employ diverse strategies, ranging from macro bets by hedge funds to algorithm-driven trading focused on price trends. Gasoil and US diesel positions have seen a slight increase recently, and commercial traders, including producers and merchants, are not as bearish, with some reducing hedges against potential price drops. However, the significant extent of financial traders’ bearishness raises the risk of volatility if OPEC+ decides to further cut production, leading to a rush to exit bearish bets and a surge in oil prices, exacerbating inflation concerns. Goldman Sachs estimates that substantial gains in oil prices could trigger up to $40 billion in buying from trend-following commodity trading advisers. Conversely, significant price declines are not expected to significantly impact positioning. While many forecasters anticipate a US economic contraction, the timing of the downturn keeps being pushed back due to a robust labour market, wage growth, and increased spending power resulting from accumulated pandemic savings.

Weaker economy 

Global fund managers’ sentiment has turned increasingly bearish, with 65% of participants in Bank of America Corp.’s survey expecting a weaker economy. However, the physical oil market does not align with the gloomy outlook. Refineries are processing the highest amount of crude for this time of year since the pandemic began, air travel is increasing worldwide, and US gasoline demand has reached its highest level since December 2021. Additionally, inventories of gasoline and diesel in the US are below seasonal norms, and factors such as OPEC+ production cuts and Canadian wildfires have limited crude supply. Consequently, oil producers and industry players are scaling back on hedges against price drops, and swap dealers, who typically execute hedges for producers, are becoming less bearish as some drillers buy back their protection. The International Energy Agency has raised its forecast for global oil demand growth this year, driven by China’s post-pandemic recovery. However, optimistic expectations have not materialized entirely due to weak industrial demand, hindering traders from taking bullish positions on diesel.

Oil and assets 

Traders are closely monitoring China’s recovery, particularly whether the increase in consumer-driven consumption can offset the weakness in industrial demand. The ongoing stalemate in US debt-ceiling talks is also discouraging speculative traders from unwinding their bearish positions, as the uncertainty negatively affects risk-sensitive assets like oil. While a reversal of bearish sentiment is not imminent, a continued decline in inventories may contribute to oil outperforming other asset classes. There is the belief that in a capital-disciplined and under-investing environment, commodities, including oil, have the potential to outperform over a longer period when the economy stabilizes.

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Source: Yahoo