Tuesday, August 30, 2016

Preparing for September

Last week ended with another heavy statement from the Federal Reserve Chairwoman, Janet Yellen, addressing her fellow central bankers at an annual conference at Jackson Hole. Her words, "In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months," were enough to inject a small dose of volatility into trading on Friday. Equities which had grown earlier in the day weakened in later trading, and the dollar jumped against foreign currencies.

from WSJ
Trading opened the week with Yellen's remarks in mind and a fresh batch of economic data in the morning. Income and inflation metrics met consensus estimates with earlier estimates revised slightly upward. Personal income and consumer spending inched upward in the last reported month showing signs that the economy has begun to stabilize, but a small increase will fuel pessimism surrounding third quarter results in a couple months. Consumer goods and services should be wary of a flat consumer consumption growth, and utilities will have the edge. Sluggish prices also fuel the slow growth trend that the Fed will reconsider in September. A "lower for longer" oil scenario translates to a limp PCE index which could discourage any hawkish action by the Federal Reserve during the next meeting. An inflation target of 2 percent looks very lofty when looking at yesterday's numbers. According to projections in June, PCE inflation should be at about 1.4 by the end of 2016, but the current reading of 0.8 suggests a pessimistic outlook. On the other hand, Core PCE is on target to meet the Fed's projections of 1.6. Most sections of the economy appear to be moving fine which supports Yellen's comments on Friday. Perhaps the most troubling numbers are personal income and consumer spending which appear stagnate. If more optimistic data supported a growing consumer, then a low rate of inflation wouldn't be as dangerous.

Inflation could be supported September when OPEC meets for the second time to consider an output freeze. In the last meeting, a sanctionless Iran ruined any hopes for a deal when it asserted that it needed to resume production to pre-sanction levels. After a couple months and a 600,000 increase in Iranian output, OPEC members will try again. Investors initially traded the news bullishly, but losses on Monday and Tuesday this week suggest that most don't think that a deal will go through. The pessimists have a good reason to doubt the chances as well; the current state of the oil market is bullish for countries and companies looking to produce more. OPEC's own monthly reports have set the scene perfectly with updated data.


  • Spot prices are significantly higher 


Every major crude oil spot price is trading higher over the past couple of months. Brent crude and the OPEC basket price have gains over $1,00 higher than WTI crude oil suggesting the international oil market may even be more balanced than the U.S. market despite the output freeze failure. The members' own price metric has grown the most according to a percentage calculation implying their situation may be improving faster. If an output freeze couldn't be negotiated at April 17th prices, then a deal in September will be unlikely especially considering an end-of-the-year target around and above $50 a barrel for Brent and WTI.

  • Oil consumption estimates and projections are bullish 

Monthly reports gauged global oil consumption as higher in August than in April. For the month of April, world growth in consumption was expected to be 1.2 million b/d for the 2016 year, but four months later, the same number came in 30,000 barrels higher at 1.22 million b/d. The increase is not enormous, but it asserts a positive outlook on the demand side which will bolster more production from OPEC members. The report upgraded demand estimates for North America, Europe, Africa, and India. The important players are India and Africa as they will be major sources of demand growth in the near future. On the other hand, Chinese demand was revised slightly lower along with Latin America which had the largest decline. A source of concern may be China's flat demand trend. The Asian giant is a neighbor to many OPEC members, and thus, has become their biggest consumer. A strong China is necessary for the cartel's survival. Oil product markets also looked to be heating up in some areas of the globe. In the United States, the product markets showed more demand which could bolster OPEC exports. Asian markets, though, appeared to weaken. This bearish concern may outweigh U.S. product demand strength in the long run.

Since the oil market is turning in their favor, participants at September's summit will be less likely to conclude with a deal negotiated. Yes, revenue streams are still pinched, but the small amount of breathing room that the market has allowed will send producers into a wild-goose chase for more market share. The competition could threaten the survival of the oil cartel, in the long run, a death that would shake the global economy to its core. With two important meetings in September (Fed and OPEC), the month has the potential to instantly shift the current market trend in either direction.

No comments:

Post a Comment