Brainard pours a little oil on troubled waters ..... and incidentally, on the subject of oil, there's still plenty of it about ....

Tuesday 13th September 2016

Brainard pours a little oil on troubled waters ..... and incidentally, on the subject of oil, there's still plenty of it about ....

ref:- "Rate-rise prospects fade further as Fed policymaker urges caution", The Financial Times

If you read the more excitable headline writers, stocks had been undergoing a "mini-rout" over the previous two trading days. The more sanguine might describe the most significant reversal since the Brexit upheaval as nervy, overbought markets understandably re-examining the risks posed by potential changes in central bank policy. Bonds too had been under the cosh, though as we discussed yesterday the weakness in government debt markets seen since Friday (after Fed official Rodengren's hawkish comments) was an extension of a downside move that has been going on for a while now. Their reappraisal started a fair bit earlier.

Anyway, both markets were able to take comfort in the words of Fed Governor Lael Brainard, the last of the Fed officials to speak before they enter self-imposed purdah ahead of the Fed policy meeting on Sept 20/21. Details of her remarks are all over the media this morning, but two things in particular occurred to us as the markets were able to stop the rot and even recover a little as Ms Brainard's cautions against a premature rate hike were being digested.

Firstly ..... we know that every investor / trader / analyst has to prepare for the unexpected, and to consider every risk. But really .... how many people thought that the arch-dove Ms Brainard would advance anything but a doveish interpretation of the decision facing the Fed? Yes, yes ..... we know that we mentioned yesterday the remote possibility that she might shock us all because ..... well, you have to, don't you? But we never actually believed it. Obviously some people did though ..... futures markets imply the probability of a Sept 21st hike is down to about 20% (from about 30% pre-Brainard). In essence, nothing has changed: Ms Brainard is a dove, it's odds against a rate rise and the Fed Open Market Committee does have splits on the issue so it's not a done-deal yet.

Secondly ..... it's always of interest to note how two bodies of opinion can interpret the same fact so differently. In this instance we're talking about how the Fed has comparatively little ammunition at its disposal should things go pear-shaped once again. Ms Brainard is of the view that this argues against a rate hike since a premature rate hike could cause a reversal in the economy that the Fed would lack the tools to combat. The hawks on the other hand would argue that it's precisely this lack of ammunition that makes it imperative to normalise rates as soon as possible (i.e. get them higher), so that the Fed DOES have the room to lower rates should things take a turn for the worse.

We can see that both arguments carry water ..... nevertheless, is it not a little disconcerting to see how the most influential policymakers can disagree so diametrically on such a fundamental issue?

ref:- "Crude glut set to continue, says Opec", The Financial Times, Markets and Investing

You wouldn't say that the recent history of crude oil provides much of a lesson for producers of any commodity in how to manage prices to their best advantage. Of course, that wasn't the point for the Saudis for whom regaining market share was everything. But however chaotic their attempts to support prices with genuine production agreements may have been, you can't deny that oil producers can from time to time talk a good game.

It's easier to goose a market when the speculators are heavily short and liable to run for cover almost at the mention of production quotas, but in fairness certain producers did it pretty well back in June. It's easy to say now but frankly even then there seemed very little chance of getting the various major producers to modify their own very different agendas enough to come close to a workable consensus. That didn't stop the bold words sending a nervous market back up some way above $50 before reality set in.

We've had another talk-driven rally recently close to the $50 level when it was revealed that just about all the major producers will hold meetings on the fringes of a get-together in Algiers the week after next. The markets have offered their own view on how likely a tangible result from those talks may be (WTI Crude trading at $45) , but those producers most damaged by low oil prices (most obviously Venezuela) will be praying that there's more than hot air behind talk of a deal to boost prices this time. There had better be, because contrary to what we had been led to believe by the industry, if there isn't then the near future doesn't look much better than the recent past.

Opec itself has forecasted that supply will continue to outstrip demand well into 2017  --  you may remember that the supply/demand equation was supposed to be back in balance by the end of this year. The fly-in-the-ointment is higher estimates for non-Opec production, boosted largely by output from a US shale oil industry proving more resilient than expected and by new fields in Kazakhstan. This comes at a time when Opec production still tops 33m barrels per day, close to record levels.

There are few more cynical than us when it comes to deals among antagonistic oil producers, but if a deal is not exactly likely in Algiers (and it isn't) we may be a step closer than we were. The Saudis and the Russians (the largest non-Opec producers) have at least agreed to work together to stabilise the market.  Moreover, the key Iranians are close to regaining the 4m bpd production level that they enjoyed pre-sanctions and that has been seen as a prerequisite to them participating in any deal to limit output. Of course, they've then got to work with the Saudis, and for both parties that may yet prove to be an insurmountable hurdle.