Global Investing

Oil price slide – easy come, easy go?

One of the very few positives for the world economy over the second quarter — or at least for the majority of the world that imports oil — has been an almost $40 per barrel plunge in the spot price of Brent crude. As the euro zone crisis, yet another soft patch stateside and a worryingly steep slowdown in the BRICs all combined to pull the demand rug from under the energy markets, the traditional stabilising effects of oil returned to the fray. So much so that by the last week in June, the annual drop in oil prices was a whopping 20%. Apart from putting more money in household and business purses by directly lowering fuel bills and eventually the cost of products with high energy inputs, the drop in oil prices should have a significant impact on headline consumer inflation rates that are already falling well below danger rates seen last year. And for central banks around the world desperate to ease monetary policy and print money again to offset the ravages of deleveraging banks, this is a major relief and will amount to a green light for many — not least the European Central Bank which is now widely expected to cut interest rates again this Thursday.

Of course, disinflation and not deflation is what everyone wants. The latter would disastrous for still highly indebted western economies and would further reinforce comparisons with Japan’s 20 year funk. But on the assumption “Helicopter” Ben Bernanke at the U.S. Federal Reserve and his G20 counterparts are still as committed to fighting deflation at all costs, we can assume more easing is the pipeline — certainly if oil prices continue to oblige.  Latest data for May from the OECD give a good aggregate view across major economies. Annual inflation in the OECD area slowed to 2.1% in the year to May 2012, compared with 2.5% in the year to April 2012 – the lowest rate since January 2011. While this was heavily influenced by oil and food price drops, core prices also dipped below 2% to 1.9% in May.

JP Morgan economists Joseph Lupton and David Hensley, meantime, say their measure of global inflation is set to move below their global central bank target of 2.6% (which they aggregate across 26 countries)  for the first time since September 2010.

After peaking at 3.9%oya in September 2011, global inflation is expected to dip to 2.4%oya this month. If our top-down model is correct, global consumer price inflation could slide to just 2.1% by
year-end, 0.5%-pt lower than both our forecast and central bank targets. The risks are most skewed to the downside for the developed markets (DM), where consumer prices are more
sensitive to moves in oil prices.

The JPM economists say this modeled outcome undercuts their own house forecast and if the model is correct, this could accelerate monetary easing by central banks and boost consumer spending.

Stumbling at every hurdle

Financial markets are odd sometimes. For weeks they have fretted about the outcome of the Greek election and its impact on the future of the euro zone as a whole. But today they appeared to dismiss the outcome despite a result that was about as positive as global investors fearful for euro zone stability could have hoped for.  So what gives?

The logic behind the weeks of trepidation was fairly simple and straightforward. After an inconclusive election on May 6, a second Greek poll on June 17 was due to give a definitive picture of whether Greeks wanted to stay in the euro and with all the budgetary conditions necessary to keep EU/IMF bailout funds in place.  If a victory for parties wanting to scrap the bailout agreement and austerity led to a halt of EU/IMF funds, the fear was that Greece would inevitably be forced out of the single currency bloc in time too. And if that unprecedented event happened, then a chain reaction would be hard to avoid.  If one country goes back to its domestic currency, despite all its debts being denominated in euros, investors would then find it impossible not to assume at least some element of euro exit risk for fellow-bailout recipients Portugal and Ireland and possibly even Spain and Italy, where doubts remain about their market access over time.

Extreme tail risk or not, this set the scene for the jittery markets that ensued during the Greek electoral hiatus of May 6- June 17. Athens stocks lost more than 17%;  Spanish 10-year government bonds lost more than 7% and the euro/dollar exchange rate was down almost 4%. etc. The fear of euro-wide contagion was so-great that the Spanish bank bailout in the interim had a little or no positive impact. And with the global economic growth picture weakening in tandem with, and partly because of, the euro mess, then prices reflecting world demand in general were hit hard by concerns that another shock to the European banking system could trigger a reversal of trillions of euros of European bank lending from around the globe. Crude oil dropped almost 14%, broad commodity prices and emerging market equities lost about 8%.

Investors face a battle for clarity

How are we looking? Fluid, very fluid!

In a classic case of call and response, the latest twist of the euro saga has seen the crisis escalate sharply in Spain and Italy (with the attempted cleanup of Bankia the latest trigger for a surge in government borrowing rates in both) only to see the European Commission today invoke major policy responses including the proposed use of the new European Stability Mechanism (ESM) to directly recapitalize euro banks, a single banking union, a euro-wide deposit protection system and even pushing back Spanish budget deadlines by a year.

It seems clear from this that they see Spain and Italy – which seem to be trading in tandem regardless of their differences – as the battleground for the survival of the euro. The gauntlet is down for next month’s summit, though the absence of a roadmap to Eurobonds per se will disappoint and markets are not going to sit quietly for a month. Moreover, the Grexit vigil has another fortnight to run before any clarity and the latest polls are not going in the direction other euro governments had hoped, with anti-bailout parties still in the lead. And we can only assume Ireland votes in favour of the now notional fiscal pact tomorrow as per opinion polls, though there’s always an outside chance of an upset.

So, seeing ahead even a month seems like an impossible task. A week ahead, however, points the spotlight firmly at the ECBs meeting on Wednesday and the chance the central bank eases again in some form to try and buy time for other developments to work through. But it will also be a moment of potential conflict, with its role in the Spanish bank bailout fraught with disagreements to date. Despite a two-day London market holiday, the week will be dominated by central banks at large – the BoE meeting and Bernanke’s testimony on Thursday being the other highlights. Is there a chance they act together again? And Italian/Spanish/French bond auctions next week certainly look precarious in the current environment.

Research Radar: Greek gloom

Greek gloom dominates the start of the week as new elections there look inevitable and talk of Greek euro exit, or a Grexit” as common market parlance now has it, mounts. All risk assets and securities hinged on global growth have been hit, with China’s weekend reserve ratio easing doing little to offset gloomy data from world’s second biggest economy at the end of last week. World stocks are down heavily and emerging markets are underperforming; the euro has fallen to near 4-month lows below $1.29; safe haven core government debt is bid as euro peripheral debt yields in Italy and Spain push higher; and global growth bellwethers such as crude oil and the Australian dollar are down – the latter below parity against the US dollar for the first time in 5 months.

Financial research reports on Monday and over the weekend were just as gloomy, but plenty of interesting takes:

Bank of New York Mellon’s Simon Derrick’s view of the Greek political impasse concluded “there is at least an evens chance that the latter part of this summer will see what had officially been seen up until last November as an impossibility: a nation leaving the EUR.”

Research Radar: Beyond Hollande and Holland…

Markets have been dominated this week so far by the fallout from Sunday’s French presidential election, where Socialist Francois Hollande now looks set to beat incumbent conservative Nicolas Sarkozy in the May 6 runoff , and the collapse of the ruling Dutch coalition on Monday.  Public anxiety about budgetary austerity in Europe was further reinforced by news on Monday of a deepening of the euro zone private sector contraction in April. That said, euro equity, bond and currency prices have stabilised relatively quickly even if implied volatility has increased as investors brace for another month or so of political heat in the single currency bloc. The French runoff is now on the same day as the Greek elections and May 31 sees Ireland going to the polls to vote on the EU’s new fiscal compact.  Wall St’s volatility gauge, the ViX, is back up toward 20% — better reflecting longer term averages — and relatively risky assets such as emerging market equities remain on the back foot. The euro political heat and slightly slower Q2 world growth pulse will likely keep markets subdued and jittery until mid year at least. At that point, another cyclical upswing in world manufacturing together with the passing of the EBA’s euro bank recapitalisation deadline as well as the introduction of the new European Stability Mechanism may well encourage investors to return at better levels.

Following are some interesting tips from Tuesday’s bank and investment fund research notes:

- JPM economists reckon finding the reason behind the backup in US weekly initial jobless claims over the past couple of weeks is key to assessing whether a sub-par March payrolls report is repeated in April. It says it’s possible the claims jump move is a seasonal factor as unadjusted claims are closely tracking 2007′s pattern and Easter holidays fell on the same dates in both years. If 2007 was repeated, there would be a sizeable late April drop in claims and JPM looks for some of that on Thursday with a 14,000 forecast drop. (Reuters poll consensus is for a 11,000 drop)

Play the mini-cycles, not the euro crisis

For all the headline attention on euro zone political heat over the next six weeks or so  (Spain is already in the spotlight, Sunday is the first round of the French presidential elections, Greece goes to the polls on May 6, Ireland votes on the EU fiscal pact on May 31 etc etc),  global investors may be better rewarded if they follow the more mundane runes of the world’s manufacturing cycle for tips on market direction.

As showcased by the IMF this week, the big picture global growth story remains one of a relatively modest slowdown this year to 3.5% before a substantial rebound in 2013 to well above trend at 4.1%. Of course, there are some who think that’s hopelessly optimistic and others who may quibble about the absolute numbers but agree with the basic ebb and flow.

Yet within even these headline numbers, many mini-cycles are  playing out — especially within manfacturing, which accounts for about 20% of global GDP.  But problems in deciphering these twists and turns have been compounded over the past year or so by the impact from natural disasters and supply chain disruptions such as Japan’s devastating earthquake and Thailand’s floods.

Slipping up on oil and Greece?

Thursday’s crude oil price surge to its highest in almost 4 years (apparently due to a subsequently denied report from Iran of a Saudi pipeline explosion…phew!)  illustrates just how anxious and dangerous the energy market has become for world markets yet again this year and HSBC on Friday spotlighted its threat to the global economy and asset prices in a note entitled  “Oil is the new Greece”. The point of the neat headline hook was a simple one:

With Greece disappearing, at least temporarily, from the headlines, investors have quickly found a new source of anxiety thanks to the recent surge in oil prices

Just like many investors and strategists over the past month, HSBC rounded up its various assessments of the impact and fallout from higher oil prices, stressing the biggest risk comes from supply disruptions related to the Iran nuclear standoff and that any major political upheaval in the region would threaten significant crude spikes. “Think $150 or even $200 a barrel,” it said. It reckoned the impact on world growth, and hence the broader risk horizon depended on the extent of this supply disruption and the durability and scale of the price rise.  Worried equity investors should consider hedging their portfolios by overweighting the energy sector. Obvious winners in currency world would be the Norwegian crown, Malaysian ringitt, Brazil’s real and Russia’s rouble, the bank’s strategists said. The most vulernable units are India’s rupee, Mexican and Philippines pesos and Turkey’s lira.