04-May-2020

1) Oil Market Special: Has Oil Bottomed Out?
2) Trump Heads Back To the Future
3) Gold Weekly: Uptick in Geopolitical Risk Breathes New Life into Gold Markets
4) Euro Area Macro Monitor: When Will We Recover?

 

 

1) Oil Market Special: Has Oil Bottomed Out?

June Brent traded up with nary a settlement risk to be seen as the contract was taken off the board overnight. For July Brent, the new front month is trading up towards $27 and its discounted cousin, July WTI, moving in on $22.

Lovely bounce off the lows for June WTI this week as the change in the direction of travel reflects traders refocusing on the inflection point in demand; the gradual lifting of mobility restrictions in large economies is helping.

Upbeat remarks from Dr. Fauci regarding testing of Gilead’s Remdesivir virus treatment added to the bullish day as anything that helps with returning economies’ ‘new normal’ to something that resembles old normal is exceptionally bullish for oil markets.

And the EIA inventory data offered up some small hints of encouragement; the crude build, while significant, was a little less than expected and the gasoline draw was interpreted as a sign of some improvement in demand.

Last week was the second straight week of inventory and product demand figures suggesting a bottoming of the US market. The crude inventory build of 9.0Mb (plus SPR +1.2Mb) was bullish vs. consensus +10.6Mb and API +10Mb and smaller than the previous week’s.

Technical selling pressures are usually relatively short-lived. And on the first signs that market shorts were losing the upper hand after the colossal oil funds rolled forward, it probably signaled speculative money to move in on front end weakness.

Both WTI and Brent oil front contracts are up, but it’s the fall in the contango that is far more interesting. The fact oil prices along the curve are providing much better price discovery should bring investors back, fingers crossed.

But as June long positions reduce, so does June delivery risk and this allows June WTI to trade on a more fundamental scrim. The latter is extremely important; it will probably lead more brokers around the world to lift the DNT (do not trade) enforced restriction and bring back more investor interest in spot markets.

Demand has most likely troughed with several large economies now considering ‘exit strategies’ or a ‘new normal’ and lifting draconian lockdown restrictions. All the while, OPEC+ quotas are due to kick in on Friday, suggesting short term supply conditions have likely peaked. There’s probably another 3-5 dollars left in the June tank, which should take us to or through the 20-dollar inflection point.

With some technical overhang left in WTI, the front-month remains prone to roll on en masse. Position traders will likely take advantage of narrowing front-month contangos to execute roll strategies at opportunistic times, especially on the move under $2 forward. This could weigh until long positioned June WTI open interest is low.

However, this is a battle of the execution algorithms that provide extremely poor price discovery when the sell-buy risk management protocols are executed. The market makers’ execution engines see these trades coming a mile away and the program immediately pulls down their pricing ladders on the first sign of selling momentum, as the machine assumes a June-July swap is coming as, given the liquidity conditions, no one is going to trade June WTI in large size unless they need to.

That could be why we saw a whippy move during the 4 PM London Fix yesterday. Although that time is primarily a currency hedging channel, the London close is also a time for colossal settlement risk across a broad spectrum of assets.

But, over the short term, if WTI prices can close above $20.27 – a critical inflection point for oil prices, which is the day before the steep drop that saw nearby May futures plunging into negative territory for the first time in history – the impact of last week’s historical splat in crude oil prices would be lessened while also boosting sentiment.

 

2) Trump Heads Back To the Future

President Trump’s election strategy in November seems clear already, and it is already weighing on markets globally. The US President, and his coterie of officials, appear intent on deflecting any blame for their allegedly inadequate response to the COVID-19 pandemic domestically, instead, heaping the blame on China for everything. President Trump and Secretary of State, Mike Pompeo, have been busy pumping out rhetoric for the last four days to that effect. Populism to become popular appears to be back with a vengeance in Washington DC.

There may well be elements of truth to DC’s allegations. However, not one shred of concrete evidence has been presented by Washington DC to prove these allegations. Populist talk is cheap, and hard facts have never bothered the US President before I will grant. Still, the threat of deteriorating relations with China abruptly ended last week’s markets rally. For obvious reasons, the timing could not be worse for this to occur. President Trump also has today once again mentioned complying with the trade deal, tariffs and punishing China if necessary. The threat of a resumption of the US/China trade war hangs over financial markets in Asia this morning. President Trump needs to put some hard facts on the table, or risk sending the world into an L-shaped, trade-war driven recession on top of a recession, that even bottomless monetary and fiscal responses cannot soften.

The damage from COVID-19 was plain to see in Asia this morning. April Manufacturing PMI’s from Indonesia, Malaysia, Myanmar, Philippines, South Korea, Taiwan and Vietnam all collapsing this morning from their already poor March prints. In Australia, ANZ Job Ads for collapsed to -53.1% in April, following a 10.0% fall in March. Manufacturing PMI’s to be released across Europe and Latin America, are likely to paint a similarly daunting picture. Honk Kong GDP is expected to fall 3.0% YoY today, and US Factory Orders look set to fall by 10.0%.

 US Composite PMI is likely to fall to around 27.0 tomorrow with EU-wide PMI’s and German Factory Orders likely to tell a similar story. Fridays US Non-Farm Payrolls for April are forecast to fall by a staggering 21 million jobs. The volte-face in sentiment – that I called completely wrong on Thursday – highlights just how fragile any rallies in asset markets are. Investors will run en masse for the emergency exits at the first hints of trouble. Last week’s rally always had an emperor’s new clothes look to it, too much UV (shaped recovery), being harmful to the skin. The economic damage from COVID-19 is evident, as are the dangers of too much UV. Someone needs to tell the US President before he rolls out his go-to populism strategy as an election strategy.

 Liquidity will be affected in Asia this week with a number of holidays falling due. Japan’s will be away until Thursday for Golden Week. Mainland China does not return until Wednesday. South Korea is away tomorrow, and most of South East Asia absent on Thursday for Vesak Day.

Underwhelming results from Apple and Amazon, but most especially Trump China-bashing, abruptly ended the week-long equity rally on Friday. The S&P 500 fell 2.80%, the NASDAQ dropped 3.20%, and the Dow Jones fell 2.53%. The fragility of a rally driven by hope versus reality, has been cruelly exposed.

 More anti-China rhetoric from Washington DC over the weekend and this morning, along with nightmarish manufacturing PMI’s across Asia, has seen equities fall deeply into the red. Nikkei 225 futures, which remain open today, are down 2.85%. NASDAQ and S7P 500 futures are both 0.80% lower.

 Elsewhere, the Straits Times has fallen 2.70$%, the Hang Seng has collapsed 4.0%, with the Kospi 1.90% lower. Jakarta and KL have fallen by 2.0%. A lower Australian Dollar brings solace to Sydney, with the ASX 200 and All Ord’s eking out 0.80% gains.

 President Trump’s threats to revisit tariffs and suspend the US-China trade agreement have spooked Asia today. It is hard to think of a worse piece of news for the region, even in rhetorical form. It is unlikely to be well received in Europe or the UK either. For that reason, we expect equities to remain heavily under pressure even if the COVID-19 data across the globe shows signs of improvements today.

 

3) Gold Weekly: Uptick in Geopolitical Risk Breathes New Life into Gold Markets

Gold is moving higher as strategic hedging regimes kicked in ahead of a possible equity market rout, which is breathing new life into gold markets as prices look to primed to move higher.

The uptick in geopolitical risks is the primary catalyst due to renewed US-Sino tension after the White House put China in the crosshairs. On Friday, after a White House press conference, President Trump said that he had a high degree of confidence that the Covid-19 pandemic originated in a laboratory in Wuhan, while simultaneously threatening sweeping tariff retaliation towards China.

The renewed focus on China has prompted a flurry of press articles about possible economic retaliation by the US, but all roads lead back to trade tariffs.

Gold is highly sensitive to geopolitical events, especially as it relates to trade risks which bolstered gold throughout much of 2019 when bullion prices soared 18%.

 

4) Euro Area Macro Monitor: When Will We Recover?

As the euro area economies start to reopen slowly, the question now is when a recovery from the devastating ‘lockdown recession’ will come. PMIs plunged to new all-time lows and Q1 saw the steepest fall in activity ever recorded with a -3.8% q/q GDP contraction. Country figures suggest a sharp decline in investments, and private consumption of both goods and services was the main driver. We expect Q2 to be even worse, as the easing of the lockdown measurements will only come gradually, and we currently track annual GDP growth at -5.2% in 2020E.

The negative impact on inflation outlook has been more muted so far. Euro area HICP inflation reached 0.4% in April, as energy price decreases were offset by a surge in food prices and an upward bias for core inflation, resulting from imputations of services prices. COVID-19 significantly impacted the data quality. In France, for example, the prices of more than four-tenths of the consumption basket have been imputed. Although the medium-term implications of the coronavirus pandemic for inflation are uncertain due to opposing supply and demand shock effects, disinflationary forces are likely to accumulate as the crisis progresses.

Nonetheless, several mitigating policy initiatives could counteract this negative outlook. First, the ECB’s timely response to prevent financial fragmentation and support credit provision and the EU emergency support package are important ingredients (see below). Second, short-time working schemes such as Germany’s ‘Kurzarbeit’ seem to have helped mitigate job losses according to anecdotal evidence and the latest PMI readings. Last, electricity consumption showed signs of increased activity after the gradual opening in Italy, which indicates that activity could rebound quickly once economies reopen. Overall, the most important factor for a rebound in activity is still the size and length of the lockdown measures.

To help hard hit economies, the EU unveiled an emergency support package, aimed at providing a safety net for workers, businesses and sovereigns. It consists of a mix of EIB loan guarantees, ESM credit lines and a scheme to help governments fund short time work, totaling EUR540bn (3.2% of EU GDP). As an additional element, the commission plans to present a proposal on a recovery fund with a ‘sound balance’ between grants and loans. While ‘corona bonds’ are off the table for now, the EU will likely boost the firepower of the recovery fund by borrowing in the market. We expect EU leaders to make a final decision on the recovery fund in late Q2 at the earliest.

After the ECB’s latest bank lending survey pointed to surging loan demand and tightening credit standards amid COVID-19, the ECB launched a new series of pandemic emergency longer-term refinancing operations (so-called ‘PELTROs’) and sweetened the terms on its existing targeted longer-term refinancing operations (TLTROs). We believe these ECB measures to boost credit growth are an important step to support the economic ‘restart’ once lockdown measures are lifted. We expect the ECB to step up its PEPP by another EUR250bn and extend the APP at the June meeting, but leave policy rates unchanged.