In early 2022, major central banks stepped up monetary tightening to stem rising inflation and recalibrate their overheated economies amid continued strong global economic growth. These restrictive measures, combined with the COVID-19 situation in China and geopolitical developments in Eastern Europe, contributed to oil market volatility during the year.
By the end of 1Q22, inflationary pressures forced many major central banks to tighten even further, most notably the US Federal Reserve, which also had a significant impact on oil markets. However, the trend and pace of the policy was not the same in all countries. The Bank of England hiked interest rates through the end of Q4 21 and the US Federal Reserve (Fed) followed suit with a first announcement of hikes in interest rates from Q1 22 and continued further hikes through year-end . Meanwhile, the European Central Bank (ECB) and Bank of Japan kept their accommodative interest rates on hold for an extended period to support markets and keep capitalization rates low.
This divergent monetary policy had three main results, namely: (1) strengthened the US dollar, (2) increased the average cost of capital, and (3) inverted the US short-term to long-term bond yield curve. Regarding the first point, since most commodities are traded in US dollars, the appreciation of the US dollar against other currencies led to an increase in commodity prices, including oil. In addition, the US dollar’s appeal as a safe haven increased given the sharp and rapid rise in US interest rates relative to other currencies.
In addition, the strengthening of the US dollar, coupled with the Federal Reserve’s rapid monetary tightening, put upward pressure on non-US Treasuries and amplified the sell-off in non-US bond markets, leading to some fragility in the global economy. In addition, the rise in US interest rates increased the cost of capital and discouraged capital investment, particularly in the oil industry. In addition, high interest rates weighed on investor risk appetite and contributed to a liquidity squeeze that also impacted oil futures markets. On the third point, the rapid tightening of monetary policy in the US has resulted in an inverted yield curve, with short-term interest rates being higher than long-term rates. This is widely seen as a warning sign that the US economy is likely to slide into recession in the coming months.
Monetary policy divergences also emerged in the emerging markets. China maintained accommodative interest rates to support its economy. However, its economy continued to be challenged by zero-COVID-19 policies and ongoing problems in the property and construction markets, contributing to a drop in oil demand for the country in 2022 from the year-earlier time, when its economy was hit by rising commodity prices was supported. India resisted a rate hike earlier in the year, providing a basis for relatively strong economic growth in 2022, but then decided to hike rates until 2Q22. While oil demand in the country remained strong, inflation had a limited impact as India benefited from discounted Russian crude imports.
By the end of Q3 22, monetary tightening policies were largely coordinated across all major central banks, with the exception of China and Japan. By the end of the year, however, the Bank of Japan also became more restrictive in tightening its yield curve controls. It remains to be seen to what extent monetary tightening will dampen economic growth, particularly in advanced economies, and subsequently weigh on oil demand in 2023. In the face of ongoing challenges, the OPEC and non-OPEC countries participating in the declaration of cooperation will continue to coordinate their efforts to maintain a balanced and stable oil market to support healthy global economic growth.
Source: OPEC
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