It
is not at all hard to imagine which way things are going with
instability in Saudi Arabia and the move towards war in Syria
Oil
Moves Toward $80 and Challenges Economic Expansion
23
April, 2018
Crude
oil prices have nearly reached $70 a barrel this year, and tensions
in the Middle East coupled with a resurgence of U.S. and Canadian
shale production could move that price to $80 soon. Many consumers
may have trouble with the rise in gasoline and heating oil costs that
come with such a high price. So will companies that rely on oil, gas
and oil by-products.
Oil
prices have not been near their present level in three years. They
were last at $80 in March 2014. The average price of a gallon of
regular gasoline was $3.40 then, which is almost 25% higher than
current gas prices.
Many
economists believe that the next downturn will be due to rising
interest rates, a trade war (particularly with China) or a single
event like a military incident with North Korea. This rise in oil
prices could be just as damaging, but more insidious. Gas prices, for
example, may only rise by a few pennies a week. By late summer, they
could pop over $3, particularly because of the supply demands of
summer driving that culminate over the Labor Day weekend.
High
oil and gas prices could hurt the economy when it relies most on
consumers in the fourth quarter of the year, and particularly the
final two months. Retail sales, in particular, would be threatened by
a falloff in consumer discretionary income. Wages have not risen
rapidly in the past few years, and for many workers they have not
risen at all. That makes them particularly vulnerable to a rise in
gas prices.
One
of the most heated debates about oil prices recently is that the
Organization of Petroleum Exporting Countries (OPEC) would like to
see oil above $80 per barrel and is prepared to act to push prices
that high. Investment bank Goldman Sachs has forecast that crude
could reach that level sometime this year.
The
idea that oil might reach $80 was almost out of the question a few
months ago. That has changed fairly fast.
Deutsche:
Another $5 Rise In Oil Would Unleash Market Turmoil
23
April, 2018
While
traders have been closely following the push
higher in 10Y yields, which
this morning rose as high as 2.996%, as well as the dramatic
short squeeze in
the dollar, they may be ignoring the one asset class that is
responsible for both moves: crude
oil.
Recall,
it is the ongoing move higher in crude prices that has sent
10Y breakevens
surging to 4 year highs, while
expectations of rising inflation have in turn boosted nominal yields
as well as sent odds for 4 rate hikes to cycle highs...
...
translating into a relentless dollar bid, which is creating a
feedback loop forcing the record number of dollar shorts to
aggressively cover their positions.
So
how much higher can oil prices rise, before there the adverse
feedback loops and unintended consequences swamp out the risk-on
sentiment?
According
to Deutsche Bank's chief Macro Strategist, another $5/barrel increase
in oil would be enough for US 10y yields to threaten 3%, which also
suggests that "oil
is now at the cusp of levels where higher prices will spark greater
FX and broader asset market volatility."
As
Ruskin notes, "oil is working its wonders on inflation
expectations. Figure 1 shows 10y breakevens again slavishly following
oil around" and calculates that according to market beta
regressions, "a
$5/b increase in oil is worth at least 10bps on 10y
breakevens. Assuming
that real yields and breakevens if anything remain positively
correlated (see figure 2) a WTI near $75/b could precipitate US 10y
pushing through 3%."
As
shown in the next chart, breakevens have been following real yields
higher. Real yields, meanwhile, have been benefiting from some impact
from fiscal policy; positive productivity/ growth expectations; and,
most recently, a better risk environment as it relates to a range of
political issues, inclusive of trade protectionism, N.Korea and
perhaps Syria.
Further,
as discussed previously, the Syria story with its associated Russian
sanctions angle, has
awakened dormant commodity price pressures, with the CRB now finally
threatening levels last seen in 2015,
although some of these have eased in the past 24 hours following
suggestions from the US Treasury the Trump admin may be willing to
ease back some of its Russian sanctions, unlocking Rusal aluminum
supply-chains.
Meanwhile,
higher commodity prices are falling on a market that should be
receptive to some broader increase in inflation in the US. In a
remarkable example, Thursday's Philly Fed prices received hit their
highest levels since 2008, (see figure 4), a
number consistent with core CPI inflation rate up near 3% in 2019.
Meanwhile,
Deutsche further adds that the threat of FX vol is also rising as oil
vol and FX vol are normally intertwined, in part because oil vol
should encourage some uptick in bond vol. Implied
oil vol has already picked up a little (see Figure 5), while other
markets are lagging.
Bond vol is regarded as at the epicenter of any broader increase in
vol across all asset classes.
The
good news, for FX traders, is that they can easily put positions on
to capitalize from the above trends:
In FX land, betas over the last year show the biggest beneficiaries of higher oil prices should be: COP, NOK, CAD, ZAR, BRL, AUD. In that order.
The EUR has a small positive beta with oil, and, the USD tends to lose out slightly when oil goes up. However the oil - USD causation can run both ways, and is dominated by weaker USD helping oil , rather than higher oil weakening the USD. Oil also has an impact on Central Bank expectations. The ECB has historically placed more emphasis on total inflation than the Fed, helping higher oil prices to be associated with a stronger EUR, but this is less of a factor in current markets.
Deutsche
also lays out the "most obvious casualty" of rising oil
prices:
If we are in a world where oil prices only stabilise or edge higher, and where risk appetite is resilient, the most obvious casualty should be the JPY.
With
the USDJPY surging above 108.50, so far this is being validated.
Finally,
the biggest question: what happens to the all-important dollar? Well,
here Ruskin says that if oil is a factor pushing US bond yields to
new cycle highs, the USD is likely to perform strongly across the
board. And sure enough, as discussed earlier, the USD is indeed
surging.
So
while bullish hedge funds, and OPEC, understandably
are hoping that the next stop for oil will be $100 (and
higher), be careful what you wish for: all that would take to break
the back of the already fading "economic recovery" would be
for the price of oil to spike so high, it trigger a VIX spike and
price turmoil across all other asset classes, in a mini rerun of
2008... incidentally, just the scenario
we warned about last night.
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