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Takeaway: Ahead of a dovish FOMC statement, crude oil is appropriately testing its TREND line of resistance. Longer-term, however, we remain bearish.

Q: "Was curious if you have a theory on why seems to be strong while the DXY has held in there pretty well.  Has the set up changed where you might get more bullish on oil?"

A: The setup hasn’t changed from our perspective. We definitely think a lot of this rally in oil is a function of what has quickly become a semi-consensus narrative on the buy-side – i.e. the Druckenmiller “dollar decoupling” view. He’s been right thus far in the YTD, as the inverse correlation has essentially dissipated:

Risk-Managing the Short Squeeze in Energy - DXY vs. WTI 

Oil is still broken quantitatively, but our intermediate-term TREND line of resistance of $57.54 is definitely within striking distance:

Risk-Managing the Short Squeeze in Energy - 1

To the extent this squeeze overcomes that level and decides to test the next probable mean reversion zone, there’s a lot of risk to manage between last price ($55.95) and our long-term TAIL line of resistance of $72.12 – 29% that is!

While crude oil would still be broken from a long-term perspective on any price below $72, it’s hard for any investor to be short for a move like that, which is probably why short positions in the futures and options markets dropped -10.6% WoW in the most recent reporting period. Anyone who shorted crude around its YTD lows is likely being forced to cover on any semblance of a developing bullish narrative.

To that tune, our recent discussions with investors suggest there is a sizeable contingent of investors who believe the eventual [negative] supply response will prove to be sustainably bullish for crude prices, but we do not buy that narrative. We actually think domestic production growth will actually start to re-accelerate then, given how sharply it decelerated in recent months. E&Ps are in the business of producing crude oil; they can’t sit on the sidelines in perpetuity.

Risk-Managing the Short Squeeze in Energy - 2

When does the pain trade on crude end? We continue to view the 4/29 FOMC statement as a catalyst for immediate-term dollar debasement and reflation plays like energy and emerging market assets are definitely front-running what we think will be a dovish statement, on the margin, in light of the recent trend of disappointing economic data.

Risk-Managing the Short Squeeze in Energy - U.S. Econ Surprise Index

From there, we think the DXY trades higher into the summer months as our policy divergence theme carries on. Neither Draghi nor Kuroda will allow the USD to sustain a series of lower-highs vs. the EUR and JPY, respectively.

Long live the currency war,


Darius Dale