While market participants will hardly need the caution, having experienced historic moves in the oil complex over the past few days including the biggest two-day surge in seven years at the end of last week, one reason why oil remains so remarkably jumpy on even the tiniest hint of supply rationalization as demonstrated this morning by the latest comments by the Iraqi oil minister, is that the short interest in both WTI and Brent is at nosebleed record highs and continues to rise with every passing week.
As SocGen writes this morning, "we have seen extreme short positioning building up in the oil futures market. The quantity of short positions opened is at an all-time high for Brent, and still high for WTI futures."
SocGen correctly notes that there is now an asymmetric profile on oil: "a positive surprise could happen quite sharply, as short positions are likely to be squeezed by a profit-taking move. On WTI, the in-the-money short positions are really dominating at the front end of the curve while out-of-the-money long positions are dominating at the long end of the curve: the front end of oil curve could thus be more exposed to some profit-taking."
SocGen's conclusion is that "deflation fears could turn around rapidly and give more room to reflation and inflation talks" which considering all central banks are now actively blaming low oil prices for their monetary incompetence, is indeed notable.
However, a bigger point is that a sudden jump in oil, one which reprices inflation expectations due to the increasingly more benign base effect, would also therefore revert the hawkish Fed to its original rate hike forecast, one of 4 increases in the Fed Funds rate in 2016, which as a reminder is what unleashed the market volatility in the first place by forcing China to devalue both relative to the USD and relative to a basket of currencies.
As such, perhaps it is only a matter of time before a sharp oil squeeze forces the now record price correlation between oil and risk assets to reverse dramatically on concerns of even more tightening by the Fed and an even more aggressive reaction by the PBOC. Indeed, as SocGen itself admits, "If the strength of the US dollar is the main reason behind the collapse of the commodity/emerging markets complex, a more dovish Fed stance would help."
Alternatively, a dramatic squeeze higher in oil prices would make a more dovish Fed far less likely.
Perhaps Citi, and as of today Deutsche Bank, are right: perhaps we are indeed approaching the day when central bank intervention is not only not stimulative but in fact pushes equity prices lower.
Until then, we leave readers with what is the simplest catalyst for today's surge: the chart showing that the days ahead of FOMC announcements (like the one tomorrow) almost without fail lead to a dramatic stock market outperformance.