Why is the Fed (not the Middle East) influencing the price of oil?

The oil price extends losses with a drop of up to 1% in trading on Wednesday, May 22.

For the third consecutive day, crude oil fell, in the wake of expectations that the Federal Reserve could maintain US interest rates higher for a longer period due to sustained inflation, potentially impacting fuel use in the world’s largest consumer.

Precisely the moves of the US central bank, with the direct consequences on consumption, economic growth and the strength of the dollar, are influencing the black gold prices. Investors who observe the Middle East with some apprehension, in fact, have seen that so far the impact of the Israel-Hamas war and internal Iranian events has been very weak. The geopolitical risk on oil supply is quite low for now.

The Federal Reserve, however, is at the center of attention in the oil sector and can impact the price of crude oil with his future decisions.

There is a Fed effect on the price of oil

The weakness of Brent and WTI prices, which trade at 82 dollars a barrel and around 78 dollars a barrel respectively, both falling at 12.00 on 22 May, is explained more in the USA than in the Middle East.

First of all, it should be underlined that oil prices slipped following the news of theincrease in crude oil and gasoline inventories in the United States last week, according to market sources citing data from the American Petroleum Institute (API) on Tuesday. Analysts had expected a decline.

Physical crude markets have weakened and, in another sign that concerns about limited and timely supply are easing, the premium of the first-month Brent contract over the second, known as Backwardation, is near its lowest level since January . In technical jargon, when a market is in Backwardation (a condition in which the current (spot) prices of goods or other assets exceed the expected value of future prices) it is more likely that energy companies will withdraw oil from storage and use it now rather than waiting for prices to drop in the future.

Crude oil, therefore, is rather weakened. But not so much from Middle Eastern dynamics, which have so far been rather irrelevant. In fact, it is the Fed which is most orienting the oil market.

Some officials said Monday they were waiting for further signs of decline in inflation before the central bank can start cutting interest rates. Two senior Fed officials said they were not yet ready to say inflation trends are again moving sustainably toward the central bank’s 2% target, reflecting after last week’s data showed easing pressure on consumer prices in April.

Lower interest rates would reduce financing costs for consumers and businesses, which could stimulate economic growth and demand for oil. Conversely, higher financing costs can slow economic growth and put pressure on oil demand.

Investors then await the minutes of the Fed’s latest policy meeting and, after the API data, the latest official data on US oil inventories provided by the Energy Information Administration (EIA) later on Wednesday.

“The minutes of the Federal Open Market Committee (FOMC) will be reviewed for the Fed assessment of erratic inflation of the first quarter and for clues about the timing and scope of potential interest rate cuts in 2024.”analysts at ANZ said in a report.

Any details will also offer prospects for oil. In contrast, there currently appear to be no decisive drivers from the Middle East on the horizon for the oil sector. The market appears increasingly insensitive to developments on the market geopolitical frontlikely due to the large amount of spare capacity OPEC is sitting on according to Warren Patterson, head of commodity strategy at ING.