I’ve condensed just some of the stuff I read so far – and I’m only half done. The more I read the more I am convinced of the market’s view to short USD in the long run – even though I am long it for the short run. What the fed’s going to say later today is in my view highely unlikely to deviate from market expectations, and a lot of the plethora of USD-negative information has been priced in already, as you can see from the DXY chart, which really is at a point of inflexion now. In my view, the meeting later will leave with it more USD volatility rather than direction, and so I shall keep my positions relatively small and remain long for the short term, since the market is so lobsided right now. But if the fed gives us a USD-negative surprise (unlikely), and the DXY breaks the techincal support on the weekly chart, then I will consider closing out my USD longs and replacing the USD in my portfolio with other currencies.
Here’s all the information I’ve considered so far:-
United States Outlook Update: Déjà Vu…Summer 2010 Redux?
The race to the bottom has started again. Consensus is rapidly adjusting to a slower speed for the U.S. economy in H1. Growth forecasts for 2011 are significantly weaker than hoped for at the end of last year, when the economy was benefitting from a degree of positive momentum and another round of fiscal stimulus raised hopes for stronger growth.
The past few weeks of data releases have largely disappointed and point to anemic growth of 1.5% q/q annualized in Q1, compared with our previous estimate of 2.5%, taking our annual growth forecast for 2011 to 2.4%. (We discuss our Q1 growth downgrade in detail in the forthcoming North America Focus.)
Higher gas prices are certainly weighing on discretionary spending. Confidence took a hit in Q1, and auto sales (which drove the robust pace of spending in Q4) slowed in March. Adjusting for higher prices, we estimate consumer spending rose by 2.1% in Q1, about half the pace of Q4, and headwinds from elevated gasoline prices are expected to remain in place for some time. Construction looks very much weaker in Q1 (led by non-residential structures) and we project the boost to growth from the sector will be limited this year. Inventories likely had a significant positive effect on growth in Q1 after the low level of stocks at end-Q4, but the inventory cycle has now run its course. The contribution from net exports looks largely flat in 2011 and the outlook on the fiscal front has certainly weakened, given the increased federal bias toward fiscal austerity, in addition to the drag from state and local governments.
Final sales are poised slow to below 0.3% in Q1 and, given the slowdown, it is only natural to draw comparisons with summer 2010, when growth slowed significantly, the housing sector started to weaken, inflation slowed perilously and the eurozone crisis exacerbated a volatile environment where wealth destruction and anemic growth were hitting confidence hard. Today, the economy is a bit more resilient—job creation has improved and core inflation appears to have bottomed. However, there is no lack of downside risks, including the housing double dip, the fiscal drag and the risks from external disruptions (such as events in Japan/MENA/pressure from oil and other commodities/stress from the EZ crisis, as detailed in our April “Cross Asset Monthly†by the RGE Market Strategy Team).
Core inflation and inflation expectations have crept upward and could make for a difficult year for monetary policy makers (although, in our view, the upward pressure will be limited and core inflation will remain well below target). Fed officials have stepped up the hawkishness of their rhetoric, but speeches by the key FOMC members suggest the Fed will remain more concerned about growth risks. With the IMFand consensus adjusting their growth projections downward, the Fed will once again play catch up.
For now, QE2 will come to an end this quarter, and the Fed is likely to maintain the size of its balance sheet for some time (more on this in a forthcoming RGE piece). We hold our view that the first rate hike will occur in Q3 2012. QE3 remains unlikely, but a further sustained growth slowdown that renews concerns of a growth dip (a fat tail risk) could increase the probability.
U.S. New and Existing Home Sales Show Gain in March
- Overview: In March, new home sales rose 11.1%, reaching 300,000 SAAR—after touching a new record low, of 270,000, in February. In March, sales rose in three of the four regions; with the biggest gain coming from the Northeast region. The average price of new homes sold continued to erode on a y/y basis, down 6.1%. Existing home sales rose by 3.7% m/m to 5.1 million in March, after a 8.8% in drop in February. The national median existing home sales price (NSA) fell back 5.9% y/y in March, a faster pace of decline than in February. Previously, the Pending Home Sales Index—a leading indicator of existing home sales based on contracts signed on homes—showed a 2.1% m/m increase in February. (Contracts on homes are usually closed with a lag of 1 to 2 months, when they are recorded as existing home sales.) Following the expiration of the homebuyer tax credit in April, the declines in home sales were substantial, giving way to some stabilization, only in late 2010. Early 2011 sales have been weak.
- RGE View (Apr 25, 2011): We have maintained that we do not envisage a resurgence in housing demand in the near term, but we expect housing demand to follow a sideways trajectory. The stabilization in new and existing home sales in March, after sharp drops in February, is in line with this view. The existing homes market will see greater improvement for the remainder of 2011, benefitting from discounts on distressed properties (40% of total sales in March involved distressed properties; 35% were all cash sales which involve a price discount). The new homes market will also see competitive deflation, but will lag behind. A modest recovery in the labor market in 2011 will support housing demand, and given household formation, some excess inventory will get absorbed in 2011—though with consumer income still weak, household budgets and consumer confidence stretched by gasoline prices, housing demand will recover slowly. We expect new home sales to average around 320,000 for the year.
U.S. FOMC Minutes: No Change to QE2, Stress on Inflation Expectations and Divergent Opinions on Exit
- Overview The evidence of some divergent views among FOMC members has been prominent, with some regional Fed presidents delivering hawkish speeches, while speeches by New York Fed President William Dudley, Fed governor Janet Yellen provided some counter-hawkish perspective. The divergence was also evident in the March FOMC meeting minutes, where a few participants indicated “a move toward less-accommodative monetary policy this year; a few others noted that exceptional policy accommodation could be appropriate beyond 2011.” The meeting minutes also indicated that the ongoing large-scale asset purchase program (QE2) would not be tapered towards its completion, that the economic recovery was on a firmer footing and that the labor market was gradually improving. The effects of commodity prices on headline inflation were seen to be “transitory,” though commodity prices posed both upside risks to the outlook for inflation and downside risks to consumption and investment growth. Along with QE2 purchases, the committee retained the pledge for exceptionally low levels of the Fed funds rate for “an extended period.” The Fed’s second large-scale asset purchase program, “QE2,” involving the purchase of US$600 billion in longer-term Treasurys by the end of Q2 2011, was announced at the November FOMC meeting.
- RGE View (Apr 11, 2011): Recent speeches and the March FOMC meeting minutes have highlighted some divergence among Fed officials about the appropriateness of policy accomodation after QE2, some stressing upside risks to inflation while Yellen and Dudley touched on downside risks to consumption and investment. FOMC minutes also indicated there appears to be a debate on the extent and relevance of resource slack for determining inflation, while the importance of monitoring inflation expectations was stressed. Despite the greater prevalence of hawkish rhetoric recently, as at least some of the fiscal-policy-induced boost to household income may be allowed expire in 2012, we envision no premature broad-based discussion of monetary policy withdrawal. We expect that the Fed will maintain the size of its balance sheet after fully completing QE2. The Fed may decide to phase out the reinvestment of the runoff on its securities holdings in late Q3. Given our still-subdued core inflation forecasts (1% in 2011) and an improved, but still subdued, employment outlook, RGE estimates no active policy tightening through Q2 2012.
Do Oil Prices Include a Speculative Premium?
Appears in the Briefing: Oil Prices, Advanced Economies, Frontier Markets, North America, Markets, Commodities, Energy, Oil, Oil and Energy
Apr 27, 2011
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RGE Share
- Overview: Oil prices fell by over US$6 a barrel on April 11 and 12 amid warnings that the high price of oil does not reflect easing supply-demand fundamentals; OPEC believe a US$15 to US$20 a barrel premium is attached to the price of crude. Prices have risen as political unrest continues to grip the Middle East and North Africa (MENA)—WTI had been trading at over US$111 a barrel, and Brent at US$123 a barrel as of April 8. A protracted conflict in Libya looks likely as Muammar Qadhafi’s troops battle rebel forces for oil fields and key terminals, damaging infrastructure. Libya’s sweet, light crude exports declined by 75% or 995,000 barrels in March, and OPEC production also declined despite production boosts by member countries, led by Saudi Arabia, which ultimately failed to cover the Libyan shortfall. Political unrest in MENA countries is ensuring a fear premium remains attached to the price of crude. Prior to events in MENA, oil prices had been trending downward on news of increased OPEC production and verbal intervention by Saudi Arabia in an attempt to ward off US$100 oil.
- RGE View (Apr 8, 2011): Continued unrest in MENA has led us to increase our crude price forecasts for the year to US$98/barrel for WTI, and US$110/barrel for Brent. We expect the oil markets to remain highly volatile. The ongoing civil war in Libya is likely to disrupt oil supply for a number of months. Rebel oil exports are unreliable due to fighting at key oil terminals and fields. Damage to oil infrastructure will ensure supply disruption even if a peaceful resolution is found. Further, OPEC’s inability to cover the supply shortfall is worrying, especially in light of violence in the Niger Delta and strikes in Gabon—all of which, along with Libya, supply light sweet crude, the preferred blend of European refineries. Even with resumption of supply, a fear premium is likely to remain attached to the price of crude, with unprecedented political unrest across MENA. Strong global liquidity has enabled the crude oil markets to attract additional investments globally, and a weak U.S. dollar continues to support the energy markets. Oversupply at Cushing will ensure that the spread between WTI and Brent remains in the short term.
Price Correction and the Fear/Risk/Speculation Premium
- Oil prices corrected by nearly US$6 a barrel on April 11 and 12. In a April 12 research note, Goldman Sachs’s Chief Energy Analyst David Greely said that the recent rally in oil prices was overdone: “While prices are back at levels of spring 2008, supply-demand fundamentals are significantly less tight… we believe that the market will experience a substantial correction toward our $105 a barrel near-term target for Brent crude oil in coming months.” Goldman had previously noted that “nascent signs of demand destruction in the United States,” the possibility of a Libya ceasefire, and no sign of supply disruptions in Nigeria despite elections, could all put downward pressure on oil prices, according to Reuters.
- Since trouble erupted in Egypt on January 25, net-long NYMEX WTI managed money positions have increased by 64% from 172,013 to 281,579, despite an 8% decline in week ending April 12. RGE expects further corrections to the price of oil, in line with our WTI forecast of US$98 a barrel for the year (year-to-date WTI has averaged US$97 a barrel), as the risk premium diminishes; Â the risk of contagion and further supply shocks within MENA appears to have declined with the region in an unstable stalemate.
- Danske Bank, in their Commodities Quarterly report released on April 19, believe that crude oils “geopolitical risk premium” is set to stay at an elevated level in 2011, and will be priced out gradually in 2012. They put a fair value price to Brent of US$100 a barrel, which results in a US$20 a barrel risk premium. They believe the unpredictable situation in MENA countries means further escalation of the crisis cannot be ruled out. Meanwhile, OPEC’s spare capacity is already under pressure. They believe a further 4mb/d of crude could potentially be at risk in the region, excluding Iran and Saudi Arabia. Danske forecast Brent oil prices to trade in a US$100-130 barrel range in 2011 with an average of USD$116 a barrel with risk tilted to the upside. In 2012, they expect Brent to average US$119 a barrel.Analysis Danske Research Commodities Quarterly Apr 19, 2011Rising energy costs support metals and grains alike
- OPEC’s Secretary General, Abdalla El-Badri, has said that crude prices include a premium of US$15 to US$20 a barrel and that the market is adequately supplied—although not oversupplied, according to Bloomberg on April 18.
- In a March 21 research note, Goldman estimated that every one million barrels of oil held by speculators contributes to an 8 to 10% rise in the oil price. From mid-February to late March US$10 was added to the risk premium. Reuters put the risk premium on WTI crude at between US$21.40 and US$26.75/barrel, as of April 12.
- Danske Bank believe that the current market, as of February 28, 2011, attaches a risk premium of US$20 to the price of a barrel of Brent. The fair value price should be close to US$90 to US$95 a barrel. They use a fair value model based on U.S. stocks, OECD and Chinese industrial production, EUR/USD and speculative positioning.