OPEC production cut could derail market rally

The best two-day gain on the ASX 200 since early 2020 could come undone if the OPEC+ cartel opts to slash oil production in a move to push oil prices higher.

Just about everything has gone right for risk assets so far this week.

US and Australian sharemarkets have had their best two-day gains since the start of the post-pandemic bull markets that followed the start of unprecedented policy stimulus in 2020.

The UK dropped part of its unfunded fiscal plan, the Reserve Bank slowed the pace of interest rate hikes and weaker than expected US ISM Manufacturing and job openings data – and indeed the slowdown by the RBA – gave hope of less aggressive hikes from the Federal Reserve.

But Wednesday’s OPEC+ meeting – at which a production cut of up to 2 million barrels a day is expected to be discussed – and Friday’s release of US non-farm payrolls data loom as significant obstacles. There’s possibly also an attempted recapitalisation of Credit Suisse in the works.

Several OPEC+ member countries are already pumping oil well below their quotas, and the cartel seems to be floating bigger and bigger production cuts to test the waters.

The first “in person” meeting of the cartel since March 2020 could deliver a cut – including voluntary adjustments – of a “multiple higher” than 1 million barrels, according to RBC.

Moscow is pushing for a big cut as G7 nations frantically work to finalise a price cap plan to prevent a market disruption and reduce Russian revenue when the European Union’s package of Ukraine war sanctions starts in December, notes RBC’s head of global commodity strategy, Helima Croft.

“The success of the price cap plan is predicated on the principle that Russia will have no choice but to accept the mandated reduced price and continue to supply the market with its barrels,” she says. “And yet we continue to see a strong chance that Russia will start to selectively curtail output in advance of December 5 to try to change Europe’s calculus about the Ukraine war.”

Washington’s response to OPEC’s decision will require close watching and administration officials are reportedly working around the clock to stave off a big cut, appealing to countries that it maintains strong defence and strategic ties.

The concern is that a big production cut could spark a rebound in oil prices that rekindles inflation jitters and reignites fears of aggressive rate hikes and shocks a fragile global economy.

The other big hurdle this week in the non-farm payrolls data.

Investors will probably need to see a further rise in the US unemployment rate or a lower average hourly earnings rate if the “bad news is good news” narrative for the US rates outlook is to continue.

If that were to happen, the US 10-year bond yield could fall below 3.5 per cent, causing a further rapid move up in shares. But Credit Suisse worries could easily resurface in the weeks ahead.

The US 10-year bond yield fell to 3.56 per cent after hitting a 14-year high of 4.01 per cent last week, and the market-implied terminal rate of the RBA cash rate dived to 3.57 per cent after peaking at 4.33 per cent. These forces saw Australia’s 10-year yield fall to 3.63 per cent from a high of 4.13 per cent.

For shares, the strong gains this week could mark the start of significant “bear market rallies” like the two double-digit percentage point rallies in the S&P 500 that have been seen since the peak in January.

In the best case, the S&P 500 and Australia’s ASX 200 could form major “double bottom” patterns – if they take out their August peaks – setting them up for a test of record highs next year.

But with central banks remaining committed to delivering more interest rate hikes, and the depth of looming recessions and corporate earnings falls yet to be gauged, a test of record highs seems unlikely before the world’s major central banks cut rates and the Ukraine war de-escalates.

“We continue to think a sustainable low in equities requires central bank easing, as our global central bank indicator suggests the cycle will not bottom until mid-2023,” says Macquarie’s Australian equity strategist, Matthew Brooks. “On this basis, we think upside is capped at or near the long-term trend.”

The closely watched guide to the long-term trend is the 200-day moving average. After this week’s rally in the ASX 200, that line is just 3.7 per cent higher, at 7067 points.

Brooks feels the best rebounds will be in the industrials, small caps and US equities, but sees better than average potential in the real estate, technology, discretionary and utilities sectors.

“All these sectors have a high negative correlation to changes in bond yields, and more dovish expectations and a fall in bond yields should provide a rationale for a rally,” he says.

Top 100 stocks that are below their long-term trend and are outperform rated by Macquarie include Newcrest, Evolution, Goodman, Dexus, GPT, James Hardie, Ramsay, ASX, ARB and Reliance. “We think these stocks are more likely to outperform in a bear market rally,” Brooks says.

Originally published as OPEC production cut could derail market rally