The Saudis thought oil was cheap
So, figured that they’d rather keep
More stuff in the ground
And in a profound
Move, cut back production quite steep
Meanwhile now the debt ceiling’s gone
The Treasury’s set to turn on
The issuance tap
To refill the gap
In finance that started to yawn
The biggest story over the weekend was the Saudi’s decision to cut oil production by 1 million barrels per day as they are concerned the pending recession is going to further destroy demand and so are aiming to keep prices supported. No other OPEC+ members joined with the Saudis as it seems they all want the money. And who can blame them? Not surprisingly, oil prices are firmer this morning, up nearly 2%, but remain far below levels seen prior to the last OPEC+ production cut when WTI was pushing $80/bbl. However, if we look back to pre-covid times, oil was trading a full $10/bbl lower than the current level of ~$73/bbl. In the interim, we have seen significant structural changes in the oil market, and I continue to expect these changes to force prices higher over time.
First, the election of President Joe Biden led to an immediate change in US energy policy with a destruction in production capabilities in the name of global warming. Second, the Russian invasion of Ukraine and the ensuing sanctions on Russian oil (and NatGas) exports have helped reduce the amount of energy molecules available to be used worldwide. Add to this the longer-term lack of energy infrastructure investment given the ESG push for the past decade, and the supply side of the equation does not look robust.
On the demand side, however, things are likely to continue to trend higher for the foreseeable future. Despite trillions of dollars of investment in alternative sources of energy, namely wind and solar, fossil fuels continue to represent more than 80% of total energy usage worldwide. As well, every advancement in civilization throughout history has been driven by access to cheaper energy, and all those nations that we currently call emerging markets are quite keen to continue to advance their economies to the benefit of their populations. They are far less concerned about global warming than they are about better living standards. According to the IEA’s most recent forecasts, 2023 will set yet another record for oil demand regardless of the recession calls and the war in Ukraine. Ultimately, this supply/demand imbalance is going to resolve toward higher prices still. Mark my words.
As to the other discussion making the rounds in markets this morning, the upcoming deluge of Treasury security issuance, there are many claiming that this may have a significant impact on risk asset pricing, notably equities. The idea is that as the Treasury refills its TGA (checking account) with up to $500 billion to get it back to its more normal balance, it will draw liquidity from potential equity investors who decide that earning a risk-free 5+% on their money is quite attractive, thus reducing demand for stocks. However, this is a more nuanced discussion as there are other features in the money markets that will be impacted as well, and that are likely to offset a significant portion of that impact.
On the surface, that argument has validity, but digging a bit deeper is worthwhile to get a better understanding here. The Fed runs a Reverse Repo program (RRP), where they essentially pay a small subset of investors to hold their securities at the Fed funds rate. This program currently has about $2.2 trillion in it and is widely used by Money Market funds as an investment. And that money in the RRP program is stuck at the Fed and not available for other investment. However, T-bills have been yielding higher than Fed funds, and it is expected that those same Money Market funds will be snapping up the newly issued T-bills while running down their RRP balances, thus absorbing a great deal of the new issuance. If this is the case, it will reduce the amount of available risk-free assets to which the equity investors described above will have access. In other words, the feared demand drain is likely to be far smaller than the $1 trillion that has been bandied about lately. Do not count on this as a rationale for equity weakness, although that doesn’t mean there are no problems ahead.
And, as we begin another week, those are really the noteworthy stories around. After Friday’s blowout NFP number of 339K new jobs with a revision higher in the previous months, US equities took off and had a big day. That has mostly been followed by Asia, which saw strength almost everywhere (mainland China being the most prominent exception) although Europe has had a less robust session today. Arguably, that is because the Services PMI data in Europe released this morning was softer than expected across the board, and they had already reacted to the US payroll data on Friday as those markets were open during the release. Meanwhile, US futures are either side of unchanged this morning, clearly not feeling any additional love from the payroll story.
Of more interest is the fact that bond yields are higher around the world this morning, with Treasuries (+5.4bps) seeing selling pressure along with all of Europe (Bunds +7.2bps, OATs +7.0bps, Gilts +5.8bps, BTPs +8.1bps) as it seems the flood of issuance due from the US is being felt everywhere. After all, given the dollar’s recent trend higher, which is very evident today, for non-USD investors, higher yielding Treasury securities are likely to be very attractive. As to domestic investors, selling ahead of significant issuance is a time-honored tradition.
Aside from oil, metals markets are under very modest pressure this morning, which has more to do with the rising dollar than anything specific to those markets.
And speaking of the dollar, it is on top of the world yet again this morning, rising against all its G10 counterparts and almost all its EMG counterparts. SEK (-1.1%) is the worst G10 performer, after its PMI data was substantially worse than forecast with the Composite index tumbling to 47.6, a level only ever achieved during Covid, the GFC and the Eurozone banking/bond crisis. In other words, things don’t look too good there. But even NOK (-0.55%) is under pressure despite the strong rally in oil. This is unadulterated USD strength. Similarly, EMG currencies are all under pressure save ZAR (+0.6%), which seems to have responded positively to news that there would be reduced blackouts going forward.
On the data front, there is not very much this week, so activity is likely to be driven by other markets given the FOMC is in their quiet period.
Today |
Factory Orders |
0.8% |
|
-ex Transport |
0.2% |
|
ISM Services |
52.4 |
Wednesday |
Trade Balance |
-$75.5B |
Thursday |
Initial Claims |
237K |
|
Continuing Claims |
1802K |
Source: Bloomberg
And that’s really all we’ve got for today. To me, the biggest risk to markets is the fact that US equity performance is entirely reliant on 7 companies, all of which are very good companies, but whose performance has been extraordinarily outsized and does not seem representative of the economy or market as a whole. At some point, those stocks are likely to come back to earth and that will result in a very large adjustment to views about the Fed, the economy, and the stock market. But for now, it is hard to fight the trend, and that includes the dollar higher trend.
Good luck
Adf