Dear Friends,

I hope this letter finds you well.

Global equity markets have given back some of their year-to-date gains so far in September while government bond yields have moved noticeably higher in recent weeks. The market action can be attributed to mixed economic signals and messaging from central banks. On the latter, the Bank of Canada and U.S. Federal Reserve both decided to hold rates steady at recent policy meetings, while the European Central Bank raised rates yet again. All three emphasized the need to tread carefully as they try to ensure interest rates stay high enough for long enough to stem inflationary pressures. Recent inflation readings in Canada and the US suggest pricing pressures have begun to perk up, driven in part by oil prices. We discuss oil in more detail below.

Crude oil and refined products like gasoline, diesel, and jet fuel have all been on a sharp upward trajectory since June and are trading near highs for the year. Global demand and supply have both been responsible for the price gains in recent months.

Demand has been stronger than expected, driven by a more resilient economy, particularly in the U.S. where the summer travel season was notably strong. Demand in other parts of the world, like Latin America and Africa has also been stronger than expected. And, while China’s economic recovery following its reopening earlier this year has underwhelmed, its crude oil imports through the first half of the year have set a record pace, with much of it being deployed into the country’s oil inventories for future use. The International Energy Agency (IEA) estimates that roughly three quarters of the increase in world energy demand this year is expected to be driven by China.

The supply side of the equation has been as impactful. Over the past month, Saudi Arabia and Russia – the world’s biggest crude oil exporters and second and third largest producers, respectively – said they would extend their production cuts to the end of the year. Most market participants see this as a resolve to maintain higher oil prices, while Saudi Arabia has countered that sustainability of global demand is uncertain, and the country is merely tempering production to avoid oversupply.

Historically, the supply and demand imbalances that have created elevated oil prices often resolved themselves over time. Demand has typically deteriorated when prices are elevated as consumers look to moderate the impact of higher costs. Meanwhile, oil producers have predictably raised production at more profitable price levels in the past, leading to increased global supply. Lower demand, increased supply, or a combination of both have driven prices lower in prior periods.

We expect global oil demand to moderate over time as higher prices and slowing economic activity eventually take their toll. We have less conviction on the supply side where there has been a notable shift in recent years with oil companies demonstrating more discipline and patience. They have been less willing to raise production at higher prices and have clearly prioritized profitability over revenue growth. Moreover, major producers like Saudi Arabia and Russia appear intent on maintaining elevated prices for the foreseeable future, although predicting their approach from one year to the next has been fraught with challenges.

High oil prices present a headwind to inflation, which had been on a downward trajectory for most of the year until recently. This is yet another challenge for central banks, who remain steadfast in their focus on ensuring inflation can move lower and back to their long-term targets. We expect global markets will remain hyper focused on inflation through the rest of the year.

Should you have any questions, please feel free to reach out.

Have a great week.

Best Regards,

Frank