Yesterday's trading was partially driven by a surprise move by the Chinese government to lower short term interest rates coupled with the US Fed FOMC disappointing the QE3 watchers. Many market players were expecting Bernanke to signal his hand as to what action the Fed is likely to take at the June 28 - 29 FOMC meeting. Much like the head of the ECB the day before Bernanke's comment's were very open ended with no specific commitment or bias toward another round of QE. There was no conclusion or signal one way or the other as to whether or not QE3 is on the table. His comments can mostly be summed up by ...the Fed will take whatever measures are required. In the end the market did not like the vagueness of his comments and selling hit the market for the remainder of the session as the Chinese interest rate cut was overshadowed and continues to be overshadowed into today's trading session.
The last few days of trading have primarily been driven by the perception that a round of global stimulus may be on the way along with a growing view that there may be a solution to some of the EU issues...in particular the Spanish banks. In fact just this morning Germany said that aid instruments are ready if Spain applies for them. The problem facing the trading and investing community is on one hand the global economy is slowing in all corners of the world while sovereign debt issues are still evolving in Europe which is simply bearish for all risk asset markets. On the other hand there is a growing view that the Central Bankers of the world are going to crank up the printing presses and attempt to inflate their way out of some of the pending issues while trying to jump start the global economy.
So far China is the only major global economy to actually show their hand by cutting short term interest rates while liberalizing interest rates changed and paid by banks. Although the Chinese action was overshadowed yesterday I view China starting to more aggressively ease their monetary policy as having far greater implications than whether or not the US is going to embark on another round of quantitative easing. China is the growth engine of the global economy as well as the oil and commodity growth engine of the world. If the Chinese government can jump start their economy demand for oil and the broader commodity complex is going to rise and have an impact on the forward supply & demand balances and thus the price.
On the other hand as we have seen over the last several years quantitative easing has artificially supported oil and commodity prices based almost solely on a perception view that those actions were and are inflationary. Oil consumption has been continuing to decline in both the US and the EU in spite of aggressive quantitative easing programs in the US, EU and UK. So yes if any of the major developed world central banks announce new rounds of quantitative easing oil and commodity prices will rise ...at least in the early stages. However, QE by itself will not result in any growth spurt in oil consumption and in fact unless the developed economies start to grow at a much stronger pace than they have over the last several years I would expect oil consumption to remain flat at best and possibly even continue to decline further.
So how do we position our trading and hedging books going forward? As I said in yesterday's newsletter I have upgraded my thinking from bearish for oil to neutral on a combination of real action by the Chinese to stimulate their economy and an increasing likelihood of easing by the US and Europe as well as a growing view that some solution to Spain and Greece will emerge over the next several weeks. I have not taken the next step in upgrading to a bullish viewpoint as the risk of nothing getting done is still a possibility.
The underlying problems in both the US and Europe have not changed and are both bearish for just about all risk asset markets. The more negative the macroeconomic data turns out to be over the next several weeks the higher the likelihood that the US Fed and the ECB will embark on new monetary easing programs. Thus we may be entering a period where bad economic news gets a positive reaction in the markets while neutral to good news may be discounted as it could lead to status quo insofar as any new actions by the Central Bankers.
I also believe that the upcoming Greek elections will result in the pro bailout party taking control and thus resulting in the EU and Greece dodging a bullet for another three to six months. I also expect the EU to come up with some form of bailout program for the Spanish banks as well as instituting some form of bank deposit guarantees to avoid any major run on the EU banks in countries with debt issues looming. I think this will all be a positive for the markets but again there is still sizeable risk that what I just described is not the outcome. Another reason for just a neutral bias at the moment. The guessing and projecting will be all but eliminated over the next three weeks as all of the aforementioned events move into the reality mode.
Global equity markets are once again back on the defensive as shown in the EMI Global Equity Index table below. The EMI Index has recovered some of its losses this week gaining about 1.1% for the week heading into the last trading day of the week. However, most of the gains occurred earlier in the week with selling hitting most global markets over the last twenty four hours. The Index is still showing a year to date loss of 2.1% with only three of the ten bourse still in positive territory for the year...China, US and Hong Kong (barely). The way the global equity markets have been trading strongly support the view that the underlying trend of the global economy is still slowing at best. The recovery in some of the equity markets this week also reflects the growing stimulus view discussed in detail above. For the moment the global equity markets are once again net bearish for oil and the broader commodity complex.
With what is looking like a transition toward more stimulus/easing programs starting to surface around the world I am still maintaining my oil view at neutral with one eye toward the bullish side. I am starting to expect the oil complex to settle into the $80 to $90/bbl trading range basis WTI and $95 to $105/bbl basis Brent. At the moment it is not so much that the current fundamentals have changed it is more related to the fact that the market sentiment is changing as participants move into the perception mode based on more stimulus which could result in an improvement of the forward fundamentals from a demand perspective (mostly based on China easing).
I am keeping my view at neutral and keeping my bias at neutral with an eye toward the upside now that Nat Gas has moved back to much more representative levels that are in sync with current fundamentals. The surplus is still narrowing in inventory versus both last year and the five year average but could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.
Yesterday's Nat Gas inventory report was disappointing to the market as the injection level came in above most all of the industry expectations (see below for a more detailed discussions of the inventory report). The market has been in selling mode since the inventory report was released not only because of the higher than expected injection level today but a slowly growing view that the underperformance we have seen in injections throughout the injection season this year may be starting to come to an end. In other worlds we could be getting closer to a point when injections start to outperform history and if that turns out to be the case the probability of storage hitting maximum capacity prematurely will be increasing.
On a positive note with Nat Gas prices declining again today the economic advantage of burning Nat Gas in place of coal wherever possible is increasing. The differential between the spot Nymex Appalachian coal and Nat Gas prices has now widened to $0.457/mmbtu in favor of Nat Gas. At this level utilities that have switched from coal to Nat Gas for power generation will continue to burn Nat Gas. If Nat Gas remains in the $2.25 to $2.50 trading range that I have been predicting we could even see more switching from Coal to Nat Gas as the industry becomes more convinced that the economic advantage of switching will remain in play for the medium term. This will help the demand side of the equation.
Currently markets are mostly lower as shown in the following table.
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.