August 2, 2019 / 11:45 AM / 2 months ago

Column: Oil plunges as U.S. tariff threat boosts probability of recession

LONDON (Reuters) - Oil prices slumped on Thursday as the United States threatened more tariffs on China and traders concluded the probability of a recession sapping oil consumption had increased.

FILE PHOTO: A pump jack operates in the Permian basin oil and natural gas production area near Odessa, Texas, U.S., February 10, 2019. REUTERS/Nick Oxford/File Photo

Front-month Brent crude futures slumped more than 7%, a percentage change equivalent to more than 3 standard deviations for all daily price moves since 1990.

Futures prices have fallen by 7% or more on only 44 days out of more than 7,500 trading days in the last three decades, suggesting traders were blindsided by the White House move.

The last time prices moved 7% in either direction was on Dec. 26, 2018, in thin post-Christmas trading, and before that on Nov. 30, 2016, when OPEC announced output cuts.

The White House decision to increase tariffs from September, even as the two countries remain in talks, came as a surprise after both governments had appeared to want to stabilise relations at the G20 summit in June.

China has already threatened unspecified “countermeasures” in a Commerce Department statement carried by the state-run Xinhua news agency.

The tariff threat is intended to increase U.S. negotiating leverage and try to push the talks forward, but previous threats have not broken the deadlock so far.

(Chartbook: tmsnrt.rs/338l114)

RECESSION ALERT

Manufacturing activity in the United States is already expanding at the slowest rate for almost three years and in China and Europe is falling, according to purchasing managers’ surveys.

The renewed escalation of trade tensions between the world’s two largest economies threatens to heighten business uncertainty further.

Traders have responded to the increased risk of recession by marking up the probability of further interest rate cuts by the Federal Reserve.

The U.S. Treasury yield curve, which had been steepening in recent sessions on hopes the United States would avoid an outright recession, inverted again sharply on Thursday.

U.S. interest rate traders had been scaling back expectations for further rate reductions before the year-end following the Federal Open Market Committee meeting on July 31.

But the tariff threat caused rate traders to cut their expectations for the fed funds target in January 2020 by 20 basis points, almost a full quarter-point reduction.

The U.S. S&P 500 broad equity index also fell sharply and is now up less than 2% compared with the same month last year, as fears of a slowdown intensify.

In the past, when trade tensions have threatened to push the economy into a deeper slowdown and equity prices have fallen, the White House has normally tried to reassure investors that trade talks are making progress.

Something similar could happen again, but with the frustration and distrust between the two governments increasing, it may become harder to convince investors to remain patient.

Unless the two governments can change the trajectory of their trade and economic relationship, a global recession now appears more likely than not - which is the consistent message from oil, bond and equity markets.

John Kemp is a Reuters market analyst. The views expressed are his own.

Related columns:

- U.S. and China talk as manufacturers slump (Reuters, Aug. 1)

- Global oil consumption stagnates leaving prices under pressure (Reuters, July 23)

Editing by Dale Hudson

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