Saturday, 28 May 2016
Monday, 23 May 2016
#CrudeOil at 47.72 via @investingcom - http://invst.ly/o7p
Tuesday, 17 May 2016
Stagflation (high inflation rates at the same time the economy has high unemployment rates) has had, and will continue to have a greater bearing on pushing crude oil up to $50, and higher thereafter into 2017. In a stagflation environment, an increase in aggregate demand, a decrease in supply, or other factors that affect supply and demand schedules are not necessary conditions for higher prices. This fact alone can push WTI Crude Oil (CL / USO) prices much higher in the short term and is also reinforced by prices naturally reverting to the long term mean. The term Stagflation is a portmanteau of the terms stagnation and inflation, and was coined by economists during the Carter administration of the 1970s, wherein for the first time in its history the nation's economy was simultaneously in recession with inflation rising. It seems as though this phenomenon has reappeared, disguised. For instance, as opposed to the 1970s, government spending, M2, debt-to-GDP, government spending as a percent of real GDP growth, and nominal public debt are at all time highs; while real GDP growth and real wages during the past eight years are at all-time lows. Such circumstances leaves any potential real growth dependent upon sustained unsustainable debt-finance spending, which adds considerably to future price inflation.
A Hesitant Fed
An unlikely Fed hike in 2016 also puts future downward pressure on the USD and corresponding upward pressure on Crude prices. As mentioned above, real GDP growth is at an all-time low (sub-three percent for eight consecutive years), giving the Fed little if any margin for error in terms of causing a recession by raising rates prematurely (primarily in an election year). A recession before the general election equates to a major blunder for Obama, and consequently a blow to Hillary Clinton's chances at becoming POTUS. A rate hike induced recession is also likely to bring the Fed's credibility in question - an issue Donald Trump has already raised on the campaign trail and is likely to revisit in one form another during the debates. Likewise, the Fed's credibility would suffer even greater public scrutiny should they decide to raise rates, only to have reverse their position and cut again. Hawkish interest rate policy is virtually out of the question, as it risks putting undue upward pressure on the dollar and decreasing both M2 and total output as a result. Sub-three percent growth coupled with low relative productivity does little to persuade Yellen and the FOMC to rein in any potential increase in GDP growth that they may be lucky enough to muster up.
ECB and BOJ
Current ECB and BOJ monetary policy would aggravate any hawkish policy decision by the Fed. Domestic conditions that appear conducive to a rate hike will likely be offset by global conditions which are underpinned by unprecedented dovish policy by the ECB and BOJ. Both central banks have stated repeatedly that they will print an infinite amount of paper to keep their currencies relatively low in order to prevent a deflationary spiral. Unfortunately, the Fed has the same policy, and wishes to avoid deflation by any means necessary. As a result, an interest rate hike as small as 50 basis points can result in a compounded effect of the USD being bid up to unsustainable levels, as the USD is believed to be a safe-haven currency and as investors pile into the dollar in a desperate search for yield, which will only be exacerbated in an environment of negative rates and near-zero growth. As long as the ECB and BOJ maintain a monetary policy regime intended to avoid deflation at all costs, the Fed will be in the same boat with very little incentive to rock it. A strengthening dollar in such a scenario implies a relatively weaker EUR and JPY, which threatens to reduce the effectiveness of the Fed's ZIRP.
Simultaneous unprecedented monetary policy from the world's largest central banks, the red flags of signs of the reappearance of stagflation, and a justifiably hesitant Federal Reserve, combine to form the ideal catalyst for higher crude prices, regardless of the marginal supply/demand outlook. As evidenced by the ineffectiveness of the Doha talks between Russia and Saudi Arabia in terms of affecting the outlook of future crude prices, obstacles to higher prices in the near future are increasingly insignificant.
@HalftimeReport buy $CL_F on the dip, sell it at 50. short the Qs, buy it at 103 @petenajarian @ReformedBroker— Rubin (@rubinoftoronto) May 3, 2016
Sunday, 15 May 2016
At this point, several factors suggest that the result of the Doha talks has little to do with the real overall global supply/demand outlook. Firstly, slowing global economic growth makes a production freeze self-defeating. The Saudi and Russian governments are both starved for cash; reducing any form of income when growth is necessarily dependent upon deficit spending is comparable to shooting yourself in the foot with your own gun. The Saudi government is running at a near record budget deficit, so a production freeze means they would be forced to add to that deficit, or add to the difficulties of paying it down, i.e. reducing government expenditures
Secondly, the Russian economy is currently in recession. They're unlikely to opt to worsen the effects by cutting back on revenues, which are sorely needed for fiscal stimulus. Russia's debt to GDP ratio is not nearly as high as Saudi Arabia's, however, slower global growth and lower oil prices have taken a toll on government revenues which provides a generous incentive to forego a production freeze.
Finally, since 2009, essentially every government and central bank of the developed world has sustained asset prices by way of various forms of fiscal stimuli. This has hiked up sovereign debt levels in the process without creating any self-sustaining, productive, economic activity. As a result, government and central bank spending/printing is currently required on a perpetual basis in order to maintain any level of meaningful GDP growth (an extreme of the Keynesian Cross/Multiplier model).
Since 2012 Saudia Arabia's total government revenue fell by roughly (-56%); from $1.2 trillion to $546 billion today. Losing 14% percent of government revenues for four consecutive years while the country's economic growth relies on government spending details a situations that is just short of a national economic crisis. Add to that the fact that the Saudi regime is currently undergoing a reorganization of leadership in which the final decision on economic policy is held by a younger, locally educated man with decidedly different perspectives on the relegation of power and resources.
Fragile internal politics, falling revenue/subsidies, and tepid global economic growth has created risk averse regimes that are unlikely to gamble too heavily on the ability to manipulate global oil prices via a freeze in production.
The primary concern for the Fed is offsetting the potential effect that an Infinite Draghi Put could have on the dollar. Draghi has made it clear that he will stop at nothing in order to avoid deflation and hit the ECB's 2% inflation objective, as evidenced by his remarks regarding QE, stating that the end date of the monetary easing program is tentative and did not make any reference to a maximum threshold for QE or a minimum threshold for interest rates. Since low velocity of money in the euro area has dampened the inflationary effects that one would expect from the ECB's QE, and forecasts for sub 2% global growth do not provide any clear tailwinds for economic activity, Draghi has, and will continue to have to, resort to printing/devaluing the Euro in order to meet his unilateral inflation objective. Draghi telegraphed this to markets by announcing an increase in bond purchases at each consecutive one of the previous three ECB press conferences (will Greece be getting any of that free money? I think not. They'll be left to fight it out with the IMF for temporary revolving loans to keep their government from collapsing.
The problem is that the Fed, too, has inflation objectives; the Fed, too, wishes to avoid deflation at all costs; and a weaker Euro resulting from Draghi's kamikaze policy necessarily implies a relatively stronger USD, of which the Fed has little utility, in terms of its dual mandate.
Notwithstanding, Draghi and the ECB waited until the Fed washed their hands of QE before unleashing the mother of all QEs: an increase in the ECB's QE program by +33, an extension of the program until well after the US elections (and "further if necessary"), topped off with negative borrowing costs. Draghi appears to be in the exact position that Yellen wishes to be in, given that it has been eight years since the last recession, the business cycle is currently overextended, and QE with NIRP is likely the only option to cushion a severe slowdown.
On the other hand, Yellen and the Fed are in a relatively opportunistic position; they have more room to move than the ECB does, as the 10Y is still well over 1%, they haven't been forced to take rates into negative territory, and they still haven't done a Reverse Operation Twist or QE4. Slowing global economic growth as forecast by the IMF earlier in the month may mean the Fed will be forced to use those tools, however, optionality gives them relative strength, as all of the ECB's cards appear to be on the table.
Draghi's decision to ramp up QE even further and extend the program indefinitely is certainly an impediment to the Fed in terms of its ability to maintain downward pressure on the dollar while entering into the final stages of the present business cycle.