Commodities Week Ahead: Oil's Year Kicks Off With Recession vs. China Story

• IMF warns of economic trouble in all 3 of the world's growth centers
• China’s manufacturing activity shrinks 5th month in row despite reopening promise
• Dollar another wildcard for commodities, with a rebound Tuesday after a soft close for '22

The year may have changed, but the narrative in oil hasn't.

Recession fears are back at the front and center of crude markets, with the International Monetary Fund kicking 2023 off with a tough warning that the world's three main growth centers — the United States, Europe, and China — were all experiencing weakening activity.

Despite the IMF's warning, people in China's biggest cities braved the cold and a rise in COVID-19 infections to return to regular activity this week, raising hopes for an economic boost in the world's largest importing nation.

Notwithstanding that positive sentiment, Chinese manufacturing activity shrank for a fifth straight month in December, a private survey showed on Tuesday, as the country grappled with an unprecedented spike in coronavirus cases after it relaxed some restrictions intended to prevent the spread of the virus.

President Xi Jinping recently said that China's economy grew by 4.4% in 2022 - a much higher figure than markets anticipated. But he also noted that the country faces increased headwinds from the COVID-19 pandemic in the coming months.

In the United States, this week's greater focus will be on Friday's US nonfarm payrolls report for December. The jobs report is the first top-tier release of 2023 before next week's more important Consumer Price Index, or CPI, report.

The jobs report in itself is critical as the Federal Reserve faces a dilemma about tightening its monetary policy. Higher inflation and rising interest rates have hit the housing sector – and could next hit the labor market, which has shown stupendous growth for the past two years since the world came off the worst of the pandemic. On the other hand, eight nonfarm payroll reports have exceeded economists' estimates, so another positive surprise cannot be ruled out.

Economists expect an increase of 200,000 jobs, which would be lower than the 263,000 reported for November but still healthy by US labor market standards. Before the pandemic, American jobs grew by just under 200,000 a month.

In order to see salary growth cooling, "the labor market would need to expand at a pace of under 100,000 or even suffer job losses", writes Yohay Elam, an analyst at FXStreet. He adds:

"In such an 'as-expected' scenario, markets would wobble, and the US dollar could gain some ground in response to uncertainty about the Fed's next moves. The greenback attracts safe-haven flows. However, many investors would likely keep their powder dry ahead of next week's all-important CPI report."

Oil prices began the new trading year on a wobbly note as the IMF caution warning faced off with the China reopening story and uncertainties over jobs numbers and their inflationary impact.

In Tuesday's Asian trading, US West Texas Intermediate crude for delivery in February was up 15 cents, or 0.2%, to $80.21 per barrel by 01:15 ET (06:15 GMT) after dropping to as low as $79.33 earlier. WTI, as the US crude benchmark is known, finished 2022 up 6.7%.

UK-origin Brent crude for delivery in February was up 10 cents, or 0.1%, to $86.01 per barrel. Brent ended last year up 10.5%.

Despite spending five months of last year's second half in the red, crude prices still managed to end 2022 on a steady note as traders bet on resurgent demand and tighter supplies, especially with China loosening pandemic restrictions and as Russia potentially faces more Western sanctions.

Commodities saw a substantial $12.3 billion bullish flow in the week that ended on Dec. 27, the single largest weekly bullish flow in 2022, analysts at Societe Generale said in a note.

"The commodity with the largest flow was Brent, which saw a $3.4 billion bullish flow as Russia outlined its response to the EU and G7 imposed price cap on the country's crude exports to third parties."

But IMF Managing Director Kristalina Georgieva warned earlier this week that at least a third of the globe faces a recession in 2023, with the world's largest economies set to see their growth slow sharply. She also warned that 2023 would be tougher than last year for major economies.

Chinese President Xi Jinping struck a more cautious tone than markets were expecting in his New Year's address, warning of more challenges as the country enters a new phase of its COVID-19 response. Beijing had begun relaxing anti-COVID measures in December, following a year of strict restrictions on activity.

Analyst Leon Li of CMC Markets said in comments carried by Reuters:

"The market cannot expect a rapid recovery of the Chinese economy after three years of (pandemic controls), the mass bankruptcy of small and medium-sized enterprises, the soaring unemployment rate, the rapid increase in the social savings rate, and the rapid growth in the number of infections and deaths in recent months."

The dollar has been another wildcard for commodities, rebounding on Tuesday after weak finishes in the last two trading days of 2022 that helped boost the rally in oil as markets priced in the possibility of smaller Fed rate hikes this year. The central bank is widely expected to raise rates by 25 basis points when it meets in February amid increasing signs that US inflation has peaked. Last year, the Fed raised rates by 425 basis points in all.

Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about.