Analysis-Renewed inflation worries help drive oil price rally
2025.01.27 05:14
By Anna Hirtenstein
LONDON (Reuters) – Investors are snapping up futures as a hedge against the risk that U.S. President Donald Trump’s threatened trade tariffs will cause a resurgence in global inflation, adding momentum to a recent rally in oil prices sparked by a tightening of sanctions on Russia.
Oil is a popular inflation hedge because energy is a important component of Consumer Price Index (CPI) baskets and also feeds into them indirectly through goods and services costs. That means, however, that the large-scale adoption of such a strategy could itself help push consumer prices higher.
Fund managers have built up the largest net long position in crude oil futures in nine months, according to data from the Commodity Futures Trading Commission.
“This is the best hedge at the moment…if inflation in the U.S. proves to be more resistant,” said Francesco Sandrini, head of multi-asset strategies at Amundi, Europe’s biggest asset manager overseeing 2.2 trillion euros ($2.29 trillion). Amundi is increasing its commodities holdings, buying oil and metals, he said.
In an environment where U.S. stock markets came under pressure at the beginning of the year and benchmark Treasury yields hit 15-month highs, prices of oil and other commodities considered higher risk investments would typically be expected to fall, particularly as a stronger U.S. dollar made them more expensive for holders of other currencies.
However, and U.S. WTI futures prices are up around 5% and 4%, respectively, so far this year and recently traded at six-month highs.
While oil traders are focused on a tightening of supply from a fresh round of sanctions on Russia’s energy industry, some investors are concerned inflation may pick up if Trump presses ahead with threatened tariffs on countries such as Mexico, Canada and China despite the new president’s vow to lower consumer prices.
Money managers’ net long position in a basket of commodities that includes energy, metals and grains has risen close to a three-year high, an analysis of CFTC data by Saxo Bank shows, with crude contracts drawing the most demand.
According to Goldman Sachs, compared to other commodities energy has historically provided the strongest inflation-adjusted returns when consumer prices have risen faster than expected.
Energy forms 6.4% of the U.S. consumer price index (CPI) and 9.9% of the euro zone equivalent, according to the U.S. Bureau of Labor Statistics and Eurostat respectively.
If inflation is accelerating, it is likely that energy prices are picking up, which can offset losses. However, Ilia Bouchouev, former president of hedge fund Koch Global Partners (NYSE:) and author of Virtual Barrels: Quantitative Trading in the Oil Market, said inflation hedging can be a “vicious circle”.
“Investors buy oil futures to hedge against the effect of rising consumer prices, but this activity can push oil prices higher, fueling more inflation and more hedging trades, and so on.”
‘STICKY’ INFLATION
Recent economic data, such as the U.S. jobs report, has also fanned inflation fears, with a January University of Michigan survey showing an uptick in consumers’ price expectations over both the short- and medium-term.
“With strong growth combined with sticky inflation, markets are now expecting the Fed to be more cautious. Higher oil prices also don’t bode well for the inflation outlook,” said Shaniel Ramjee, co-head of multi-asset at Pictet Asset Management in London.
As stocks and bonds fell in tandem, an unusual market phenomenon, demand rose for investments that are considered less likely to lose value at the same time.
“Commodities are a good diversifier, up to a point,” said John Roe, head of multi-asset at Legal & General (LON:) Investment Management. “But if the inflation scares lead to growth concerns, then suddenly they can get caught up in it,” he added, noting the impact on demand.
The oil market rally has also pulled in momentum trading funds, according to Saxo Bank’s analysis, while Bouchouev noted that commodity trading advisors (CTAs), which typically trade on technical signals and had largely been betting on a fall in crude prices, were flipping their positions, helping to further boost prices.
