Of the mainstream commodities, oil is now 2014’s worst performer, having lost nearly 20 percent in the last six weeks, as investors, fretting about the prospects for global demand and the abundance of supply, have punished the crude market. The oil price, which is below $90 a barrel for the first time in two years, has unwound nearly half of the gains made from the depths of the financial crisis, to the four-year peaks seen in early 2012.
While lower oil prices — and the cheaper motor fuel prices that will ensue — might actually be exactly what the developed world’s cash-strapped consumer needs to start spending money, it’s inflicting undeniable pain on the oil producers. Each is waiting to see who will blink and cut first. Our guest today, Natixis head of commodities research, Nic Brown, said the squeeze extends well beyond OPEC and expects some projects in the United States, which is exporting more oil now, in the form of products like diesel, than at any time since the 1950s, to now be below cost. “We’d put (average) break-evens in a wide range, from perhaps as low as $55 a barrel to $85 a barrel, if not slightly higher,” he told participants in a multi-room chat with the Global Gold and Global Base Metals Forums.
There’s no denying there has been a shift in sentiment over the course of October. The data coming out of the likes of China and Germany, usually reliably robust, has been soft enough to spark some serious concern about the prospects for global growth. Add to that angst about apparently imminent interest rate rises in the United States, which threaten to drain flows out of the rest of the world and back into the dollar, and you have a pretty unappetising picture on the markets. Our guest today, Peter Westaway, chief economist and head of investment strategy for Europe at Vanguard Asset Management, says this gloom is probably overdone. “If you look back at the mistake investors have made over the last two years, it has been to continually expect rates to rise soon. And they haven’t. That is why we keep hearing policymakers … talking about rates lower for longer,” Peter said.
But the International Monetary Fund has cut its growth outlook, bond yields are hurtling back towards their recent lows, the currencies of “problem-child” economies such as the euro and the yen are at multi-year troughs against the dollar as the mood sours. The VIX index, which tracks volatility on options on the S&P 500 equities index and is often used as an investor “fear gauge”, is set for its largest annual percentage increase since 2008, having risen by nearly 30 percent – and most of that has materialised in the last six weeks. In the short-run, Peter says he’s optimistic in the sense that he doesn’t believe policymakers will raise rates prematurely. “I’d say I was a long-run optimist, where my take on the euro area has always been that in the long run, this (structural adjustment) will be good for Europe, but short run, it is a tough road with many mis-steps.”
The dollar is set for its largest weekly fall in nearly three years and, were this the euro or the pound, market-watchers might be a little more concerned about what that might be saying about rate expectations. Our guest today, CIBC’s head of currency strategy Jeremy Stretch, said the dollar’s bull-run that has brought it to 4-1/4 year highs this month isn’t in immediate danger of fizzling out any time soon. The minutes of the Federal Reserve’s September meeting, released yesterday, show the members of its rate-setting committee are struggling with how to come to grips with the dual threats of a stronger currency and a global slowdown. Jeremy said the temporary pullback in the dollar was more the product of disappointment that the Fed’s hawks weren’t more vociferous than of any perception that policymakers are rethinking the likely course of U.S. rates. “The Fed are just mindful of the view the more pronounced the dollar gain, the slower the rebound and CPI will be lower … Central bankers are paid to worry about risks and certain Fed members are just considering a new external risk,” he said. Economists had widely expect the Fed to introduce its first rate rise in nearly eight years in the first half of next year, but market pricing now indicates that could be as late as September.
The world’s most influential central banks appear to be parting company in terms of how they conduct monetary policy and the dollar has emerged as the major beneficiary of that divergence. The dollar has risen by nearly 7 percent so far this year, putting it on track for its largest yearly percentage gain in nine years. This development is a welcome one to the European Central Bank or the Bank of England, with their export-dependent economies to cater to, but it’s not exactly music to the ears of the Fed. “The US is not immune to what is going on elsewhere, although the degree of export dependency is relatively low. We are in an environment where many central banks have been encouraging weaker currencies versus the USD to boost exports and mitigate deflation,” Jeremy said.
This week, China has taken the boldest steps this year to revive its economy and ward off the threat of sagging house prices, by cutting mortgage rates and down payment levels for the first time since the global crisis of 2008. No one ever doubted the government’s commitment to achieve its set target of 7.5 percent economic growth, whatever the cost and Beijing’s tough response to the pro-democracy protests in Hong Kong that have brought tens of thousands to the streets in the last week highlights that commitment.
Hong Kong leader Leung Chun-ying defied the protesters’ demands to step down by Friday, with pressure also increasing from Leung’s backers in Beijing over one of the most serious political challenges they have faced in decades. Peter Ferdinand, associate professor of politics and international studies at the University of Warwick, told us this week the orthodoxy of the Chinese leadership is that the country needs economic growth first, and will develop “socialist democracy” later. “They think that premature democracy will be bad for growth – and if the demonstrations in Hong Kong lead to international damage to China’s economy, they will feel justified,” Peter said.
Another day, another UK company issues a profit warning. Last week it was Tesco, the country’s largest retailer, which cut its outlook for the third time in two months and suspended four senior executives after admitting to a multi-million pound accounting error. Today, it’s constructor Balfour Beatty, which has cut its profit outlook for the third time in less than five months after suffering contract losses and write-downs at its UK arm. Considering the amount of column inches devoted to the boom in the UK housing, investors aren’t happy and have knocked over 20 percent off Balfour’s shares as a result.
Britain’s economic growth is such that the Bank of England is likely to beat the Federal Reserve to the punch in the “race for the rate hike”. A recent Reuters poll shows most economists believe the BoE will deliver its first quarter-point rise in the first three months of next year, while the Fed will wait until the second quarter before delivering its first rate rise since mid-2006.
Welcome to a new week and the shocking revelation across the markets is that with the uncertainty stemming from the Scottish referendum – which briefly rattled markets around the world – behind us, it turns out that the global economy’s problems aren’t fixed after all. European Central Bank President Mario Draghi’s pledge to support the euro zone economy via low interest rates and cheap loans for the banks hasn’t been enough to convince our guest today, Royal London Asset Management portfolio manger Andrea Williams, that Europe’s financial sector is anywhere near being able to open the floodgates to allow the flow of credit back into the real economy and get things moving on the ground. “The problem is not one of liquidity, but lack of demand for loans. Banks say the regulator has made it too hard for them to lend to (small- and medium-sized enterprises) due to the risk weights required and many customers are still deleveraging,” she said. “Other worries (include) the lack of European economic growth. I saw quite a lot of companies last week at a conference and they seem to suggest Europe is not improving!”
The most recent ECB data shows private-sector loan growth in the euro zone picked up to show “just” a 1.6 percent year-on-year decline in July, having recovered from a record-low contraction of 2.3 percent late last year, but remains a far cry from the apparent hey-day of 2006, when loan growth hit a record high of 11.4 percent. Andrea said the ECB’s ongoing Asset Quality Review (AQR), a series of stress-tests to ensure the region’s banks have shored up enough capital to withstand any major disruption in the financial markets, should restore some confidence in the banking sector, provided the tests are perceived to be robust enough, but this alone won’t lead to a magical explosion in cheap credit for the region’s SME’s. “In terms of getting credit flowing, there is little (the banks) can do,” Andrea said. “I just think it takes time for the economic conditions to improve, for individuals to reduce the debt on their balance sheet – as long as rates stay low, it is the prudent thing to do … it’s taken the U.S. economy a few years to deleverage and Europe will take some time.” With that in mind, Andrea’s bottom line is “avoid banks”.
Scotland has rejected independence and opted instead to preserve its 300-year old union with the rest of the United Kingdom. A “No” was always the outcome predicted by the financial spreadbetters, but according to surveys in the run-up to last night’s vote, the general public appeared to be a lot more divided. Sterling has hit a two-year high against the euro, while UK shares have led advances in Europe, with Scottish-focussed stocks such as Royal Bank of Scotland, Lloyds, BP and whisky-maker Diageo contributing most to these gains.
The vote, in which 55 percent of Scots voted to remain in the union, has removed some of the risk of the UK leaving the European Union, something that Scottish independence could have precipitated. We’ve had a raft of great guests who have given us their take on the results and what they mean both politically and financially for the world’s sixth-largest economy. Marshall Gittler, head of global FX strategy at IronFX said the pound, which has touched its lowest in two years against the euro today, might not have much more scope to rally, no matter how great the relief over the union enduring. “For the pound, we’re back to looking at the data. The data hasn’t been that great. Meanwhile, investors are very long GBP!” Marshall told us, adding that market data showed a big buildup in long holdings of sterling last week as investors positioned for a “no” outcome. “I’m not sure there’s much more to go in this rally. I think profit-taking could be the next move,” he said.
Scotland decides today whether or not it will continue as part of the United Kingdom, or end a centuries-old union. The markets have been pretty quiet, but largely because most of the “will they/won’t they” action took place over the last couple of weeks and today is a day for watching and waiting. The headlines in the newspapers suggest the two sides – Yes Scotland and the pro-union Better Together – are neck and neck. But the financial markets have offered a much clearer message throughout the campaign. Our guest today from online financial spreadbetters IG Index, strategist Alastair McCaig, said all the evidence he’s seen from clients’ positions heading into the vote suggests a clear win for “No”. “IG have been running a binary bet on this for a couple of months and the lowest ‘No’ vote that has been on our platform was 62 percent. This morning, we are currently indicating an 83 percent chance of a ‘No’ win. With voter turnout expected to be almost 90 percent, Scotland looks to be taking this very seriously.”
We asked Alastair, himself a Scot based in London, why there should be such a discrepancy. ““The demographics of the voters mean that the more pro Yes have tended to be younger and many of the older voters have already posted in their opinions,” he said. “Also, younger voters more able keen to be involved on social media hence appearing to be in the ascendancy … Historically, news agencies and specifically TV have been eager to portray the image of a close two-horse race. That’s not necessarily what will happen,” he said. Voter turnout is expected to be over 90 percent, highlighting how strongly the Scots and non-Scots living in Scotland feel about this issue. That’s one thing the man on the street has in common with the man in the City. Alastair said there has been a very marked rise in the bearish bets against sterling, which has fallen by some 1.3 percent this month against the dollar to $1.638, near its lowest for 2014, ahead of the vote. He said there has been a swell in holdings of put options – contracts that give the holder the right, but not the obligation to sell an asset at a predetermined price by a set date. “We have seen a jump in trading of put options, strikes ranging from $1.6 to $1.55. In terms of hedging sterling exposure, the pound has bounced off the last weeks low and seems to be holding tight around the $1.63 mark. The bias is towards the downside.”
The Federal Reserve’s policy-setting committee meets this week to discuss the outlook for the U.S. economy and for rates. It’s something of a shame for Janet Yellen & Co that the event will be mostly overshadowed by the outcome of the Scottish independence referendum two days later. The dollar is around its highest in over a year and logic would dictate that this is a function of the growing expectations for the Fed to signal its first rate rise in almost a decade. At least that’s the theory.
The practice is a lot less dollar-centric, according to BNY Mellon chief currency strategist, Simon Derrick. The dollar has gained more than 5 percent so far in 2014 against a basket of currencies, putting in track for its largest increase in a year since 2008, the year the financial crisis exploded. But this has a lot less to do with the Fed gradually inching towards tighter monetary policy and a lot more to do with just about everything else. “It seems to me that expectations about Fed have actually been least important element in USD performance over past month,” Simon said. “Look over the past month and each USD move has really been about external factors Mid-August – that was about Japan and (its pension fund); early September – that was about the ECB and then Scotland. It feels very much as if the dollar has been the funding currency of choice over past 12 months and that what we are really seeing is a variety of factors that are denting confidence in carry trade.”
We decided to take a break from Scot-fever today and take a long hard look at how the European Central Bank’s latest lifeline will have an impact on the euro zone economy, which seems to be sinking into dangerously deflationary territory, and what it means for the euro, which is rapidly looking like the last child to be picked for the school sports team. The euro has borne the brunt of investor desire for yield and the bears are now prowling around it. The ECB last week cut interest rates to just 0.05 percent and pledged to buy asset-backed securities and covered bonds as a means of thawing out long-frozen credit flows to small- and medium-sized businesses in the euro zone. The bank stopped short of unveiling full-blown quantitative easing – where it would purchase sovereign bonds – but government bond yields have hit record lows and the euro has lost ground against every major currency bar the rouble, the Polish zloty and the New Zealand dollar over the last month as a result. But will it be worth it? Our guest today, Professor Reto Foellmi of the University of St. Gallen, said he wasn’t sure it was a price worth paying. “Concerning the ECB, I doubt whether these additional measures work. It is more of the same,” he said. ECB president Mario Draghi did the right thing by promising two years ago to do “whatever it takes” to save the euro and the commitment to buy the sovereign bonds of any euro zone nation in need of an emergency financial lifeline that met a series of conditions. “ This bought time for “real politics” but they did not use it,” Reto said, on the pressure from the ECB on the more indebted nations to bring their houses in order and implement serious structural reforms, rather than relying on handouts from the central bank. “The imbalances in the euro zone are still present and I fear more and more that we resemble the Japan experience two decades ago,” Reto added. Japan spent years trying to exit deflation and only now, having thrown trillions of yen at the economy, has started to do so. Bank of France governor Christian Noyer, who is also a member of the ECB’s governing council, said the central bank had achieved its aim of bringing the euro lower, but the currency needed to fall much further in order to raise inflation, currently running at around 0.3 percent, closer to the ECB’s threshold of near 2 percent. How much lower is “lower”? A Reuters poll taken last week showed most traders believe the euro will rise to around $1.31 in a month before falling to $1.28 by the end of the year, below its current level of around $1.29. In an informal straw poll in the forum, members were split over whether the euro’s next move over the coming week would be up or down, but in the longer run, it seems the single European currency doesn’t have that many friends out there right now.