U.S. President Donald Trump’s plan to withdraw from the 2015 accord to curb Iran’s nuclear program poses fresh uncertainty although Bloomberg Economics reckons that and similar supply shocks account for half of oil’s recent rise.
1. What does it mean for global growth?
The world economy is enjoying its broadest upswing since 2011 and higher oil prices would drag on household incomes and consumer spending, but the impact will vary. Europe is vulnerable given that growth and industrial activity already are moderating and many of the region’s countries are oil importers. China is the world’s biggest importer of oil and could expect an uptick in inflation -- prices already are tipped to increase 2.3 percent in 2018 from 1.6 percent in 2017. For a sustained hit to global growth, economists say oil would need to push higher and hold those levels. Seasonal effects mean energy costs often increase during the first half of the year before easing. Consumers can also switch energy sources to keep costs down, such as biofuels or natural gas.
2. How will Iran impact the the market?
Oil prices have risen 14 percent this year -- half of this increase reflects stronger global demand, a Bloomberg Economics model suggests. The rest is likely due to heightened tensions with Iran and other supply shocks. The return of U.S. sanctions could crimp Iranian oil exports, but the global supply shock might be mitigated by increased pumping elsewhere, according to the analysis. Here’s a chart.
3. Who wins from higher oil prices?
Most of the biggest oil-producing nations are emerging economies. Saudi Arabia leads the way with a net oil production that’s almost 21 percent of gross domestic product as of 2016 -- more than twice that of Russia, which is the next among 15 major emerging markets ranked by Bloomberg Economics.
Other winners could include Nigeria and Colombia. The increase in revenues will help to repair budgets and current account deficits, allowing governments to increase spending that will spur investment.
4. Who loses?
India, China, Taiwan, Chile, Turkey, Egypt and Ukraine are among those on the worry list. Paying more for oil will pressure current accounts and make economies more vulnerable to rising U.S. interest rates. Bloomberg Economics has ranked major emerging markets based on vulnerability to shifts in oil prices, U.S. rates and protectionism.
Analysts at RBC Capital Markets created an “oil sensitivity index” to judge the economies most exposed in Asia. They warn that Malaysia, Thailand, China and Indonesia could face the most volatility from an oil-price spike.
5. What does it mean for the U.S. economy, the world’s biggest?
A run-up in oil prices poses a lot less of a risk to the U.S. economy than it used to, thanks to the boom in shale oil production. The old rule of thumb among economists was that a sustained $10 per barrel rise in oil prices would shave about 0.3 percent off of U.S. GDP the following year. Now, says Mark Zandi, chief economist at Moody’s Analytics, the hit is around 0.1 percent. And that all but dissipates in subsequent years as shale oil production is ramped up in response to the higher prices. The Baker Hughes U.S. rig count already is at a three-year high.
As the U.S. nears the tipping point between net oil importer and exporter, some forecasts are less upbeat. Gregory Daco, the U.S. chief for Oxford Economics, estimates that if WTI crude prices average $70 a barrel this year, U.S. growth will lose half the 0.7 percentage point gain it would otherwise earn from tax cuts passed earlier in 2018.
Oil-producing states such as North Dakota, Texas and Wyoming should benefit from higher extraction activity, though Daco warns that productivity enhancements could limit that upside. Poorer households have the most to lose. They spend about 8 percent of their pre-tax income on gasoline, compared to about one percent for the top fifth of earners.
6. Will it lead to higher inflation around the world?
Energy prices often carry a heavy weight in consumer price gauges, prompting policy makers including those at the Fed to focus simultaneously on core indexes that remove volatile food and energy costs. But a substantial run-up in oil prices could provide a more durable uptick for overall inflation as the costs filter through to transportation and utilities and other associated industries.
7. What does it mean for central banks?
If stronger oil prices substantially boost inflation, central bankers on balance will have one less (big) reason to keep monetary policy on hold while the Fed moves ahead in its tightening cycle.
The prospect of the U.S. withdrawing from the landmark seven-party agreement to limit Iran's nuclear program, formerly known as the Joint Comprehensive Plan of Action (JPCOA), has ramped up energy market fears of an imminent supply shock.
"The geopolitical consequences of a possible dismantling of the JCPOA would likely to play a larger and long-lasting role in pushing oil prices higher than short-term policy uncertainty," Michael Cohen, Barclays director of energy market research, said in a research note published Monday.
Trump is likely to either announce he will not be renewing a waiver on Iranian sanctions or reaffirm his firm opposition to the global pact, Barclays analysts said. However, regardless of Tuesday's announcement, they predicted the current Iran nuclear deal would "not survive under President Trump."
"And in the next couple of years, this more hawkish foreign policy could fuel already elevated tensions in the Middle East, specifically in Iraq, Syria, and Yemen, as the hostilities between Iran and Saudi Arabia escalate," Cohen added.
Iran's oil production has rebounded to nearly 4 million barrels a day since world powers opted to ease sanctions over its nuclear program. However, external observers have warned that re-imposing sanctions could reduce Iranian oil exports by up to 1 million barrels a day — just the type of supply shock that could be price supportive.
"We would expect an inevitable jump in oil prices should the sanctions return," Cliff Kupchan, chairman of Eurasia Group, a Washington-based political consulting firm, said in a research note.
"We return to the possibility that the president's looming verdict may — to a significant extent — be a negotiating ploy and hence should not be considered a final verdict on the deal… Trump is regularly underestimated, and it's not over."
Click here to download a pdf of this article, Missile.pdf
“They’re two separate highways, but both need to exist,” said John Coleman, managing director of the fixed-income group at R.J. O’Brien & Associates, a futures brokerage in Chicago. “There has to be a channel for unsecured lending. Libor must continue. Whether it continues as the A-list rate remains to be seen.”
Ultimately, the market will determine Libor’s successor. Coleman says a better replacement for the unsecured benchmark would be the average rate from the Federal Home Loan Bank system, where thousands of lenders already transact every day. Another option is Ameribor, the brainchild of Richard Sandor, an economist who pioneered interest-rate futures and derivatives at the Chicago Board of Trade. Ameribor is a new interbank rate that reflects borrowing costs based on the transactions of members of the American Financial Exchange.
“Libor will go away and we need a rate that hundreds of trillions of dollars of contracts can migrate to, New York Fed President William Dudley said Friday at an event at Bloomberg headquarters in New York. “Eventually we’ll get a term curve for SOFR, and then the heavy lifting will occur, which is when we move the existing set of contracts that we have today that reference Libor onto SOFR.”
“For now Libor is still preferred as it’s the most liquid and deepest set of contracts that we have,” said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union, which manages over $2 billion in U.S. fixed-income assets. “But we will be watching SOFR pretty closely just to see how its received, managed and traded. We want to see how it’s received and what the major risks are with it.”Click here to download a pdf of this article, Missile.pdf
In a document entitled “Balancing the Trade Relationship,” the U.S. government made a series of demands from China at the outset of meetings in Beijing this week to resolve a simmering trade dispute between the world’s two biggest economies.
The document, seen by Bloomberg News, is divided into eight sections, ranging from trade-deficit reduction to tariff barriers to implementation. Here’s a synopsis of its key points:
Trade Deficit Reduction:
Protection of American Technology and Intellectual Property
Restrictions on Investment in Sensitive Technology
U.S. Investment in China
Tariff and non-tariff barriers
U.S. Services and Services Suppliers
U.S. Agricultural Products
“On examination, it turns out that the phrase excess capacity is slippery — rhetorically useful, but hard to pin down, even harder to operationalize, and at the same time woefully misleading.”
The United States, the European Union and Japan have accused China of trading unfairly by subsidizing bloated steel and aluminum sectors and flooding the world with cheap exports.
U.S. President Donald Trump has used China’s mammoth steel and aluminum sectors as justification for imposing tariffs on global supplies, causing an outcry from many countries.
Global Trade Alert has cataloged global trade policies since 2009 to gauge trends in protectionism, following a pledge by the G20 group of countries in November 2008 not to resort to trade protectionism as a response to the financial crisis.
There was no question that the steel sector was plagued by trade distortions, the study said, but G20 governments had grossly under-reported their own use of trade-distorting policies.
“Even before the recent steel tariffs were imposed by the U.S., the cumulative effect of the 144 American actions to limit steel imports still in effect today covered 96.8 percent of U.S. steel imports,” the report said.
Targeting excess steel capacity was “a fool’s errand”, because measuring it was very difficult, and estimates of China’s steel production capacity varied enormously, it said.
“How they choose to alter the characterization of inflation is important,” said Stephen Stanley, chief economist at Amherst Pierpont Securities. “They have been saying for a long time it’s running below target. There are shades of gray” in their portrayal.
A matter-of-fact description of the price gains would suggest the FOMC is confident in its gradual approach to raising rates and doesn’t see urgency in increasing its pace. Likewise, maintaining its description of the inflation goal as “symmetric” -- included in every FOMC statement since March 2017 -- could reinforce the view that the Fed can be patient.
Characterizing 2 percent as a symmetric target, rather than a strict ceiling, conveys the idea that the committee would be equally concerned if inflation were running persistently above or below its objective.
Officials could also say “inflation is now essentially at target and that they expect to be able to keep it in that vicinity,” said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore and a former Fed economist. “Some such language allows for a small overshoot which seems likely.”
The committee is also likely to debate how to characterize the U.S. economic expansion, which on Tuesday became the became the second longest on record. In March, the FOMC downgraded its view of growth to “moderate” from “solid.” Gross domestic product rose at a slightly quicker-than-expected 2.3 percent rate in the first quarter, making it a close call between those choices.
The labor market may continue to be described as “strong” even with data showing some unevenness. Just 103,000 jobs were added in March, according to the Labor Department, though economists surveyed by Bloomberg estimate that employment picked up in April.Click here to download a pdf of this article, Missile.pdf
“$60 is like the new $100,” said Dallas Fed economist Michael Plante in a mid-April interview.
After a two-year crash, the price of crude CLc1 began to recover in 2016 and pierced $60 a barrel early this year. But oil is still far cheaper than at the peak of the previous eight-year boom that began in 2006 North Dakota’s Bakken oil patch and supercharged the city of Williston.
In the Permian basin, which stretches across West Texas and eastern New Mexico, the latest boom is being helped by advances in technology that allow drillers to extract much more from each acre.
Breakeven costs are now as little as $25 per barrel, according to the Dallas Fed’s most recent survey, so energy companies here no longer need $100 oil to make lots of money.
“It is a full-fledged boom,” says Dale Redman, chief executive of Propetro, a Midland, Texas, firm that supplies heavyduty horsepower to drill sites, where energy companies coax crude from the ground with sand and water.
To Midland Mayor Jerry Morales, “It’s a good story right now.” He says the city is trying to keep up with the drop in housing inventory and rise in rents by approving new apartment complexes and working with developers to put in water and sewer pipes.
“Companies are making enough money to be able to afford to pay higher wages,” he said.
Unemployment was 3.2 percent in Odessa and 2.5 percent in Midland in February. Average weekly earnings in March hit records in both towns, which have a combined population of about 250,000. Sales tax receipts have soared.
“You have people that move in, you train them and then someone else offers them a job: there is constant raiding going on,” says Jeff Sparks, chief operating officer of family-owned Discovery Oil in Midland, who has only recently shifted to the more efficient and capital-intensive drilling techniques that have pushed per-barrel extraction costs down so steeply.
Commerce Secretary Wilbur Ross said in a statement that he understands the concerns of businesses, and that the department “is making an unprecedented effort to process the requests expeditiously.”
Companies are asking for relief from 25 percent tariffs on steel imports and 10 percent on aluminum.
Companies that win exclusions will be granted refunds for the tariffs, which they are currently paying. But the delays could mean tying up millions of dollars that a business would rather invest in facilities and employees, said Ann Wilson, senior vice president of government affairs for the Motor & Equipment Manufacturers Association, which represents vehicle suppliers.
“This apparent backlog creates uncertainly for our members, which puts businesses –- and jobs -- at risk,” Wilson said in a statement.
Some 3,500 exclusion requests have yet to be reviewed, while about 550 had been processed as of April 27, according to the Commerce Department. No decision on a request can be made until it’s been reviewed and posted online for 30 days for any objections.
“The Treasury’s funding needs are massive,” said John Briggs, head of strategy for the Americas at NatWest Markets. “A lot of clients we speak to around the world say they are concerned about how the U.S. is going to fund this deficit. With the supply outlook following the tax changes and new budget, Treasury yields should move upward through the year.”
Treasury officials are set to announce this quarter’s funding plans on May 2, and bond dealers expect another across-the-board boost to auction sizes, including for inflation-linked debt. The nation’s fiscal overseers may have little choice, with deficits projected to surpass $1 trillion by 2020. The deterioration in federal finances, which is putting the U.S. debt profile on track to resemble Italy’s, is becoming more glaring ahead of crucial midterm elections in November.
American taxpayers are already bearing the cost, as swelling issuance has helped drive yields on some maturities to the highest in a decade. Government debt sales will more than double this year, to a net $1.44 trillion by JPMorgan Chase & Co.’s estimate, raising the specter of buyers’ fatigue just as the Federal Reserve is shrinking its $4.4 trillion balance sheet and raising interest rates.
“We’re late in the credit cycle, and trying to figure out when everything turns,” said Erin Lyons, a senior credit strategist at New York-based research firm CreditSights Inc. “Some of these may eventually be downgraded.”
Bonds with the lowest investment grade have been a market darling over the past decade, ballooning in size as low global interest rates drew fund managers seeking higher returns. But as borrowing costs climb to a four-year high just as investors begin to anticipate a downturn in the global economy, some analysts are starting to sound the alarm.
Notes in the lowest rungs above high-yield junk -- in the BBB group from S&P Global Ratings or the Baa bucket from Moody’s Investors Service -- total about $3 trillion, almost the size of Germany’s gross domestic product. The concern is that as rates rise it will cost companies more to roll over their obligations, and if earnings begin to slump as economic growth slows, that could blow out leverage ratios and lead to credit-rating cuts.
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