The price also rises

08 Mar 2016

Key takeaways

  • The ECB was not able to provide as much policy accommodation as it had allowed investors to believe was coming
  • Metals have been rallying hard – predating any suggestion of Chinese stimulus
  • US payrolls data came in much stronger than expected with sharp upwards revisions to prior months

Full commentary

If there has been one story dominating markets this year, it has been the fall in the price of a barrel of oil. Less than 10 years ago, benchmark West Texas Intermediate (WTI) reached $145.29/bbl. The intraday low of February 11 this year was $26.05/bbl, itself a 30% fall in six weeks. Deflation is back. Weak global aggregate demand is back. Emerging markets in crisis are back. And, of course, market volatility came roaring back, leading to poor performance across most asset classes, even those previously thought to be relatively immune, as investors saught liquidity as much as safety.

There is plenty to be worried about, in what has been an unusually lengthy recovery from the financial crisis. Corporate profitability is down, and the trend is down. Highly accommodative monetary policy in the US has been tightened both by a modest interest rate hike, and an immodest strengthening of the US dollar. The European Central Bank (ECB) was not able to provide as much policy accommodation as it had, arguably, allowed investors to believe was coming. This has led to fears of divisions in its governing council, and worries that the ECB President may not able to deliver quite as much as market participants had been led to believe he could, with more to come this week. The refugee crisis has exposed strong political divisions across the continent at a time when many worry that coordination is to be desired. A UK referendum on leaving the club altogether is an unhelpful coda. Bad debts to emerging market countries such as China and Brazil suggest ominiously the contagion at the heart of the sub-prime crisis, and have manifested themselves in sharp moves in the collateral default swaps of European banks, most notably Deutsche Bank, as the structure of the contingent capital “AT1” has come under pressure. That this structure was designed in the aftermath of the crisis as one way to prevent another is particularly ominious for those who had hoped at the very least the banking run nature of the last crisis might be avoided in the future.

In amongst the gloom, fear, and occasional panic, some data points have quietly been pointing in the opposite direction. The first of these is oil. It is still, to be clear, below its level at the beginning of the year, but is currently over $10/bbl above its low. The law of small numbers flatters comparisons, but the gain from the low is in excess of 40%. This has come about from the end of some of the more pernicious effects of margining, but also because marginal producers have begun to cut supply. The effect may be more psychological than anything else given the relative inelasticity of short-term demand, but this is a sizable move.

It is not isolated to oil. Metals have also been rallying hard. The chart of the week shows the iron ore, and its 30% rise year to date. Some of that can be seen in the tail, being the 19% rally today alone following the Chinese National People’s Congress, but as the chart also makes clear, this move predates that. Iron is not the only metal which has seen sharp price appreciation: nickel, zinc, and copper amongst others have all moved in the same direction, with those moves predating any suggestion of Chinese stimulus. Emerging market indices have performed well year to date, largely on the back of stronger local currencies.

US payrolls data came in much stronger than expected, with sharp upwards revisions to prior months. Unemployment remains at 4.9%. Yet the one piece of data inconsistent with the story was Average Hourly Earnings, which fell -0.1% on the month. However, warehouse retailer Costco increased its hourly wages for the first time in nine years, by 13% for the lowest-paid. Competitor Wal-Mart raised its wages last year. It is always possible to select data to support a viewpoint, but investment bank UBS publishes a Global Inflation Surprise Index. February’s positive surprise was the largest in two years.

No one is arguing that inflation is about to come roaring back. But views predicated on commodity-related gloom injecting deflation into the global economy should be held lightly.

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