Crude oil struggles to recover on falling inventories rate hike doubts

US crude oil prices shot up to a two-week high above $47 yesterday as the Energy Information Administration (EIA) reported that crude inventories dropped by 2.1 million barrels last week. This substantial dip represented the first decline in oil inventories in three weeks. US oil production also showed a weekly drop, with a peak apparently having been established in April before a steady fall-off in output ensued.

In addition, the US dollar dropped on Wednesday as markets expressed increasing doubt over the likelihood of an immediate Fed rate hike on Thursday. This doubt was partly driven by a weak US inflation reading in the form of the Consumer Price Index (CPI) on Wednesday, which showed that inflation fell in August for the first time since January. Low crude oil prices were largely the cause of this disinflationary reading, which has complicated the Fed’s rate hike decision. Combined with the EIA data, the dollar pullback on these rate hike doubts served to lift crude oil even further.

West Texas Intermediate (WTI), the US benchmark for crude oil, fluctuated around Wednesday’s $47-area high on Thursday morning as traders awaited the pivotal Fed statement in the afternoon. Despite falling inventories and the potential for a further recovery in oil prices, the oil markets are laser-focused in the short-term on whether the Fed raises interest rates today and the ramifications of that decision.

From a technical perspective, Wednesday’s surge in WTI broke out above a large pennant pattern consolidation that originated after the rise from late August’s six-year low just under $38. In the process, price action also broke out cleanly above WTI’s 50-day moving average. The upside target for this pennant breakout is technically around the $55 price level, which would push above key resistance levels at $50 and $54.

While this technical scenario would describe a bottoming out of crude oil prices, any partial recovery in the short-term would be contingent, once again, upon interest rates and the US dollar. If the Fed does not raise rates today, the immediate reaction for crude oil should be a significant follow-through to the upside, initially towards the $50 psychological level. In the event of a rate hike, WTI should be in the position to give back Wednesday’s gains and move back down towards key support levels at $43 and $42.