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Crude oil not out of the wood yet
OPEC rally runs out of steam
After hitting $50.39 on Monday amid the positive outcome of discussion between the oil ministers of Saudi Arabia and Russia, the price of a barrel of West Texas Intermediate crude for delivery in September returned to $48.92 on Wednesday. Indeed the market’s enthusiasm following the decision to extend the supply cut deal until March 2018 was short-lived as investors got a reality check.
According to data compiled by Baker Hughes, US total oil and gas rig counts rose to 885, the highest level since August 2015, while total US oil rigs increased by 9, which bring the total to 712.
As already discussed last week, OPEC and its allies are in a difficult position as any effort they’ll do to stabilise oil prices will actually benefit the US shale industry. US companies active in the exploration and production sector are ideally positioned to take advantage of the situation. Therefore we maintain our position of continued crude oil prices gains, though modest, in the short-term. We believe it is very unlikely to see sustainable improvement in crude prices with US producers pumping like crazy while OPEC and its allies cut production. We need to see some significant improvements of the fundamentals to see a barrel of WTI above $60.
On Wednesday, the WTI extended losses to $48.38 (generic price), down 0.58% on the day, while its counterpart from the North Sea fell 0.35% to $51.47.
Fade risk inducing noise
Selling of risky asset shifted into high gear after a weak US session. The lack of real drivers has allowed noise around US politics to derail fundamentals optimism. The initial news of allegations that Trump leaked classified then demand x-FBI Director Comey pledge loyalty generated scant market impact. Yet suddenly markets have created a theme to trade-off. Given the fact that there have been no structural shifts we suspect that current bout of risk aversion to be short lived. Our defining theory for 2017 has been to avoid hype and focus on fundamentals, which we will despite lots of red on the board.
US long end yields fell, flattening the curve slightly, as investors liquidated risk assets. The narrowing of US-JP yield differential gave JPY a broad based boost providing further effect of a global concern. Despite the choppy rally in volatility (which was going to happen regardless due to ultra-low levels) the economic data continue to support risk taking. EU data indicated that growth momentum remains solid. US industrial production surged in April to its fast pace since March 2014 (house building data disappointed slight but from an elevated level). Only China industrial output came in softer than expected, yet since controlled policy tightening was the primary culprit, deeper deterioration is unlikely.
While the Trump reflation’s story has taken a hit on lower expectation for his pro-growth agenda, we remain buyer of EM FX in dips as the core themes (higher growth, low interest rates / vol, and fading protectionism) should support risk taking. USD has been on the front of much selling as weaker CPI and strong EU data has shifted the balance of tighten expectations to Euro. The low USD position suggests that in our view markets are underpricing the Fed policy path. Improvement in economic data from now till 14th June will asymmetrical favor USD.
Japan: Growth is only spurred by QE
The future does not seem so bright for Japan when looking at fundamentals. The level of debt is astonishing (€8.6 billion debt at 0% interest rate) and the population is ageing. The debt now represents 250% of the GDP.
Inflation is still very weak and Japan's policymakers have been unable to spur it. Yet, growth has increased 1.7% in Q1 and retail sales have also increased 0.5%. The data since the start of the year has clearly outperformed expectations. However today’s data such as machine orders (-0.7 y/y) or industrial production (-1.9%) are clearly on the soft side.
What really matters is that the Bank of Japan is continuing its QE. The amount of debt it owns is not reimbursable. Social security spending is growing as the population is getting older. We believe this is actually very costly for Japan. The central bank must also keep its credibly and not default. At the moment, there is no reason for less QE as it would certainly uncover all Japan’s difficulties.
In the short-term, we bet on renewed demand for the yen as it seems likely the US economy, which we also believe is overestimated, will drive investors towards the land of the rising sun. When looking for an example, towards the S&P direction, if we remove big blue chips such as Amazon, Apple or Alphabet, the S&P is actually down.
We are certainly at an inflexion point. We reload our long USD/JPY towards 115.00 with a two-month horizon.