20141113 – IT’S NOT THAT SIMPLE..

We mentioned the counterintuitive nature of the oil price decline in our blog some weeks ago, and it’s worth reiterating it, as the price of Brent hovers just above $80. That level is already a game changer for many Emerging Market oil producing countries in terms of their fiscal calculations. Russia is a great example of this, and so is Nigeria. In Nigeria the calculation for the current fiscal year assumes a $78 average price, and although we’re not quite there yet, we have already observed record lows in the naira, as hot money exits the equity and debt markets (we are currently making yet another record low in the naira this morning). When you consider that West African crude tends to be the sweetest, and thus most highly valued (Bonny light tends to trade at a premium to Brent) it’s fair to assume that there is still some margin between where real concern becomes necessary and where we are now. But it’s like musical chairs, no one wants to be the one without a chair, so you move early. Why do I bring this issue up? Well.. we also need to consider what the breakeven levels are for Shale production in the US… and my understanding is that it’s not that far away. So the question that needs to be asked is, what impact would a sub $70 price have on Shale producers? Admittedly the US economy is far far more than an oil producer, but if production slows and threatens the currently negligible level of oil imports, will that have an impact on the dollar? Possibly, but this is a new industry and we’ll need to see a real live stress test to get a better sense of the sensitivities. What does seem more likely is that we are actually closer to a base level for crude than we may realise. However that base level may not be high enough for producers like Russia and Nigeria to escape without bruising.


The quarterly Inflation Report was out yesterday morning, and the key takeaway is that the probability of rate hikes next year has receded. Inflation and growth forecasts have been trimmed and the GBP/USD weakened to new year to date lows yesterday. All I can say is… if sterling keeps weakening like this, then imported inflation might become enough of a factor to reignite rate hike chatter. Whether that encourages the Bank of England to do anything however is open to debate. Remember a few years ago when they weren’t reversing rate cuts as inflation ramped well above the target.. this is a central bank with an asymmetric reaction function. There was some positive news in the UK as well yesterday.. (quite apart from Ed Milliband’s recent leadership troubles of course!), as wage growth surpassed inflation for the first time in 5 years. That’s the one thing that might add a little backbone to Bank of England discussions next year.. if inflation and GDP do indeed decline as they suggest. Higher wage growth might just convince them that those moves are temporary.


Some Eurozone inflation data came out earlier this morning, with HICP data at the country level. Needless to say, barely any economy is generating annual inflation over 0.5%… indeed Germany looks relatively hyperinflationary with year on year inflation to October at 0.8%!! Mr Draghi has everything he needs to argue for as much monetary accommodation as he can get. This will continue to support the case for a weaker euro. Frankly the only thing that defenders of the euro (are there any?) can put forward at the moment is that the Eurozone as a whole runs a current account surplus. You only have to look at Japan over the last couple of decades.. stagnating economy.. check.. deflationary pressure.. check.. current account surplus.. check.. perceived resistance to aggressively fix structural problems.. check.. and what happened? The Japanese yen kept appreciating. I find it hard to believe that Mr Draghi.. who knows all this as well as anyone.. will permit the same to happen in Europe. But the fact he can’t unilaterally do what he feels is necessary means this view needs to be accounted for.


Not much going on data-wise for the rest of the day. There is an ECB monthly report which comes out shortly, I’m not sure much is expected from that. When I look at the chart for EUR/USD right now, it has the feel of a consolidation within a trend. We could see a bounce up to the mid 1.25s, but it seems clear to me that the risk is that the next impulsive move will be aggressively lower again. Same goes for just about everything else versus the dollar at the moment.