Oil prices continued to slip lower yesterday, pressuring the Bloomberg Commodity index to a marginal new all-time low at 74.04, as US prices briefly dropped below $30 a barrel for the first time since December 2003.

This weakness and overall bearishness initially acted as an anchor on equity markets, but the pull factor slowly started to dissipate as the day went on and equity prices started to garner a little bit of support, pulling off their lowest levels of the day.

While oil analysts competed to outbid each other with their predictions of how low oil prices might fall, with numbers as low as $10 being bandied about, short positions have continued to build up to record levels, with the selling pressure showing few signs of relenting, despite a fairly big draw in API inventory data late last night. In this context today’s weekly US crude inventory will in all likelihood be another market mover with a build of 1.9m barrels expected, up from last week’s 5.1m draw.

The main premise behind the arguments for further weakness in the oil market has been predicated on the belief that we could well see further strength in the US dollar, as opposed to the impact of future Iranian production hitting the market by the middle of this year, if sanctions get lifted as widely expected.

This US dollar strength is based on the expectation that we could well see further rate rises in the coming months and if Richmond Fed President Lacker, a renowned hawk, gets his way we could well see around four at the very least if his comments last night were any guide. Fortunately he isn’t on the voting roster this year, so this would appear highly unlikely.

Despite the overriding pessimism around oil prices both European and US markets managed to finish yesterday in positive territory, briefly snapping their recent correlations with the fortunes of the oil price.

Whilst concerns about oil prices are one factor preoccupying investors, another worry is the state of the Chinese economy, as well as the reaction function of Chinese authorities to the recent turmoil on currency and stock markets.

The recent Chinese central bank inspired pullback in the offshore Yuan may well have stabilised the Chinese stock market for now but it is becoming increasingly clear that the yuan will eventually have to drift lower, even if it has stabilised in the past day or so.

This morning’s latest China December trade data showed that exports only fell 1.4%, instead of the 8% decline expected which suggests that the recent currency falls may be starting to have an effect. Imports fell 7.6%, which was again a slight improvement and better than expected. These improvements do appear to suggest that while the economy is slowing things may not be nearly as bad as markets had been fretting about and as such we look likely to see a positive open this morning in Europe, even if Chinese stock markets don’t appear to be basking in the improvement that much.

Later today we get the release of the Fed’s Beige Book and this is likely to be particularly interesting not only in the context of wage and inflation pressure in the US economy but also given the recent sharp deterioration seen in the most recent manufacturing indicators for December, from the ISM as well as the sharp drop in Chicago and Dallas manufacturing PMI’s.

Will the Beige Book also reflect a deteriorating outlook for the manufacturing sector as illustrated by recent surveys?

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