One of the factors driving U.S. dollar strength has been the resilience of U.S. economic recovery, despite stagnation in Europe and a cooling pace of growth in primary emerging markets. Recently, however, a spate of weaker-than-anticipated economic data sets out of the U.S., combined with economic green shoots in Europe as the European Central Bank’s easing program kicks into gear, is casting doubt on the U.S. economy’s fortitude. Analysts are thus rethinking what steps Federal Reserve policy will take next.
Federal Reserve Bank of Atlanta President Dennis Lockhart took a decidedly dovish stance in a speech delivering yesterday, discussing the activity measures for the first quarter of 2015. In currency markets this uncertainty is palpable, although it has not translated into significantly increased volatility. In a note to clients today, Vincent Chaigneau, head of fixed-income and foreign-exchange strategist at Société Générale in Paris, noted his view that the euro’s long skid against the dollar is now past us, adding, “The next few months should hopefully confirm that the U.S. slowdown was weather-related, leaving the market to reprice the Fed’s path of tightening.”
Nestlé sales cool. Swiss food and beverage company Nestlé today reported sales of 20.92 billion Swiss francs ($22 billion) for the first three months of 2015, higher than the same period in 2014 but below consensus analyst estimates. The company reported a marginal decline in emerging markets for the period, with China sales a particular drag on revenues.
IMF will not allow Greek payment delay. Christine Lagarde, managing director of the International Monetary Fund, publicly reaffirmed that Greece would not be allowed a special dispensation for payments due in the coming month. The payment of roughly $1 billion currently exceeds the capital available to the government in Athens. Greek officials deny media reports that they had requested an extension on repayment, as negotiations with European Union partners continue to stall.
U.K. unemployment rate hits historic low. Jobless benefit claims in the U.K. reached the lowest rate in 40 years, according to data released today by the Office for National Statistics. At 2.3 percent, the claimant count registered its 29th consecutive contraction. Ahead of the U.K. parliamentary elections next month, this is good news for Prime Minister David Cameron’s Conservative Party.
Euro zone inflation remains weak. Eurostat March consumer price data released this morning for the 19-nation currency bloc confirmed that deflationary forces remain in play. Headline index levels rose by 0.6 percent for the month, a contraction of 0.1 percent over the same month last year.
U.S. economic data on deck. Consumer price figures for March and University of Michigan consumer sentiment survey index numbers are scheduled for release today. Consensus forecasts are for another rise in prices at the cash register after a sharp rebound in February as gasoline finally appeared to have bottomed out.
Portfolio Perspective: Much Ado About Nothing in Oil Markets — Stephen Schork, The Schork Group
Over the past four weeks, speculative net length in NYMEX WTI has jumped by 80 percent, according to the Commodity Futures Trading Commission’s commitments of traders report. This event has triggered a number of prognostications, claiming that hedge funds are charging back into oil and going massively long.
We do not buy into this theory — on a number of fronts.
Aggregate open interest for NYMEX WTI has been falling by 0.2 percent per session over the past three weeks, while aggregate trading volume is down by 1.1 percent per session. The combination of falling open interest and volume is a telltale sign that bullish speculators are not entering the market but rather, bearish speculators are exiting.
At the same time, the CFTC also reports that hedge funds are already massively long the U.S. dollar, vis-à-vis a record short position in the euro forex futures contract. Given the inverse relationship between the dollar and oil, why would Wall Street want to go long oil?
Highly indebted exploration and production companies (E&Ps) face increased financing costs. The spread on energy high-yield bonds has jumped from 330 basis points to over 800 basis points over the past year. In return, profits will drop, as will cash flow, thus increasing the chance of default. To stave off a liquidity crunch, these companies will be forced to hedge forward production, thus delaying the much-anticipated pullback in output. However, the price of poker for would-be hedgers has gone up.
Beginning in 2011 the position in WTI held by swap dealers broke a four-year range and began to collapse.
This liquidation coincided with the introduction of more stringent regulations — thanks Barney — on derivatives. Thus, at a time when the demand for hedging capacity was beginning to surge (alongside a steep rise in shale production), the capacity of swap dealers to provide liquidity to producers was slashed, thereby contributing to a spike in volatility.
Bottom line, the plunge in oil prices has changed the calculus for highly leveraged E&Ps, which in turn has put a premium on liquidity for energy-backed derivative products. As such, with the need to bring production forward, speculation of pending production cutbacks is greatly exaggerated.
Is the recent surge in speculative length responsible for the current rally? The answer is most definitely yes. Does the recent surge in speculative length mean that oil has bottomed? Just like we saw in February, the answer to that question is most definitely no.
Stephen Schork is the founder of The Schork Group, a Villanova, Pennsylvania–based energy research firm.
