The effect of plunging oil prices on market sentiment has been pronounced. Low inflation expectations, the impact of cheap gasoline on consumers in the developed world and the fate of states such as Russia that are dependent on energy exports continue to be big factors. A key question for investors adjusting to this new environment is how long oil prices can stay this low. On Friday in Stockholm, Fatih Birol, chief economist and director of global energy economics of the International Energy Agency, delivered a speech predicting that crude prices will return to the $100 level in the coming years, as long-term supply prospects prop up expectations for future pricing. Market positioning appears to support Birol’s view, with data from the U.S. Commodity Futures Trading Commission weekly commitment of traders data indicating that net long positions in West Texas Intermediate crude oil futures contracts rose by 14 percent for the week ending December 2. With Brent contracts reaching a five-year low in trading today, producers will welcome any signal that the market has hit an inflection point, even though finding a bottom and returning to prior highs are very different things.
Japanese data paints a grim picture. Bank of Japan private sector lending data revealed an increase in credit for November, aided by a weaker yen. This positive news was offset by revised figures for third-quarter gross domestic product, which deteriorated to an annualized –1.9 percent versus an initial reading of –0.5 percent. This latest information on the state of the Japanese economy will weigh on political debate as the nation readies for its December 14 special election.
China posts record trade surplus. Trade data released in Beijing today revealed a record surplus as imports dropped sharply and exports gained at a softer-than-forecast pace. Much of the decline in imports was driven by lower oil costs, while analysts ascribe slower outbound shipments to government efforts to curb unregulated capital inflows through false invoicing.
Portfolio Perspective: U.S. Rates Strategy Gaining Momentum — Rajiv Setia, Barclays
The rates market sold off last week, reversing the rally in late November. This has been driven by data that have generally been better than expected, with the payroll report looking particularly solid, as well as comments from key Fed officials signaling that mid-2015 hikes remain a good baseline. In Europe, the European Central Bank appears to be stepping up preparation for further policy easing, with bank president Mario Draghi strengthening the language with respect to balance sheet expansion, referring to the early 2012 level as “intended,” rather than “expected.” Our economists at Barclays believe that broad-based quantitative easing (including European government bonds) could be announced at the January meeting, as headline inflation continues to fall. In Japan, where elections are scheduled for December 14, Prime Minister Shinzo Abe appears likely to extend his majority in the lower house of the Diet, the nation’s parliament. Globally, monetary policy remains supportive and should become even more accommodative in 2015.
In the U.S., activity data such as construction spending, vehicle sales and ISM surveys have been surprising to the upside. Labor market numbers were also better than expected, with a welcome trend toward job gains. Having said that, while the U3 at 5.8 percent is not far from the levels when the Fed began hikes in 2004, broader measures (such as U6, at 11.4 percent) are much further away. Moreover, while month-over-month wage gains registered a strong 0.4 percent, this was mainly payback for weak prints in previous months. Year-over-year wage inflation, as measured by a variety of indicators, has remained at about 2.25 percent and year-over-year hourly compensation was also revised down to just 2.2 percent from 3 percent.
New York Fed President William Dudley noted that he favored raising rates sometime in 2015 and judged the expectation of a mid-2015 lift-off as reasonable. He also highlighted the benefits of falling energy prices and did not seem overly concerned about the adverse effect on inflation. He noted that inflation would begin moving towards the 2 percent target as the labor market tightens further and the economy expands. Stanley Fischer, the vice chair of the Federal Reserve, also noted that zero interest rates were not normal and the Fed was getting closer to getting rid of the “considerable period” language in its statement. The recent rhetoric mainly reflects increasing discomfort at the Fed with rates remaining at zero, despite the disinflationary global backdrop, given the strength evident in the labor market, While this suggests that the liftoff in mid-2015 is likely, in our view, the subsequent pace of the hiking cycle is likely to be gradual. As a result, we believe removing the “considerable period” language is unlikely to result in a material move higher in intermediate- to long-end rates.
Rajiv Setia is the head of U.S. interest-rate research at Barclays in New York.
