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11 Aug 2016
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 Thursday 11 August 2016

AM Bulletin: Equities following oil

 

 

Indices Update

It was a mixed start for European indices yesterday and initial trade was directionless. The US dollar was weaker and this helped to give gold and silver a lift. But as we saw earlier in the week the major indices were in thrall to crude oil, rising or falling in tandem with Brent and WTI. The fear amongst equity investors is of corporate defaults in the oil sector should prices head much lower. US shale oil producers are particularly exposed as these companies took out large loans back when oil was trading around $80 per barrel. At current levels these companies are finding it difficult to cover the interest payments on their debt, let alone the principal. This also exposes their lenders and the fear is that if crude breaks and holds below $40 for any length of time we could see a cascade of defaults which will have damaging implications for the wider market.

Yesterday investors were also reassessing the prospect of a September rate hike from the Federal Reserve after US productivity for the second-quarter unexpectedly fell by 0.5%.  The consensus forecast was for a gain of 0.4%. This shifted rate hike expectations back out to December at the earliest. Friday’s strong Non-Farm Payroll data reignited speculation that the Fed could look to raise rates at its next meeting on 20th/21st September. While the lower rates for longer should boost equity markets, any data suggesting that the US economy is too weak to handle a 25 basis point hike tends to weigh on stocks.

In other news there was widespread surprise after the Bank of England failed to find enough sellers for it to buy all the gilts it wanted under its new asset purchase programme. Institutional investors (such as corporate pensions and insurance firms) decided to hold on to their gilts rather than sell them to the Bank, despite the Bank bidding over market value. The Bank expects to increase its holdings of government securities by £60 billion over the next six months. But if this is a harbinger of things to come, it doesn’t stand a chance. In a statement yesterday morning the Bank confirmed it will continue with its asset purchases, as scheduled, and attempt to make good the shortfall later this year.

The FTSE 100 index closed up 15.1 points, or 0.2%, to end the day at 6,866.4

The German DAX fell 42 points or 0.4% to end the day at 10,650.9

The US30 closed down 37.4 points to finish at 18,495.7. The S&P 500 fell 0.3% to close at 2,175.5 while the Nasdaq 100 finished 0.3% lower at 4,783.4

Equities

Prudential (PRU) reported a 6% rise in its operating profit for the first half of the year. The insurer noted growth in Asia which helped to offset disappointing profits growth from its British asset management arm M&G. Operating profits came in at £2.06 billion pounds above the consensus expectation of £1.88 billion. Asian operating profits came in at £743 million against £725 million expected, up 15% from the same period last year. Profits at M&G fell 10% with the firm suffering "significant net outflows" over the last 6 months. Prudential expects its UK-domiciled operations to take a hit from the UK’s decision to leave the EU. But the company increased its interim dividend by 5% from a year earlier, to 12.93 pence per share. The stock ended the day 2.2% higher at 1,423 pence.

Commodities Update

It was another rollercoaster session in the oil markets yesterday as both WTI and Brent swung between negative and positive territory. Crude was sharply lower in early trade as investors responded to the latest API inventory report released late on Tuesday. This showed an unexpected build in stockpiles. However, crude then rallied, boosted to some extent after OPEC upgraded its forecast for oil demand growth. OPEC forecast demand growth of 1.22 million barrels a day (bpd) year-on-year for 2016, which was 30,000 barrels higher than forecast in July. The new forecast would put global oil demand across 2016 at 94.26 million bpd. OPEC attributed the upgrade to better-than-expected economic performance in advanced European economies and some Asian ones, including India, in the first half of the year. OPEC also predicted world oil demand growth would remain at 1.15 million bpd for 2017, unchanged from its previous forecast. This would see total oil consumption at a new high of 95.41 million bpd next year.

The latest update on US crude Inventories from the EIA showed an unexpectedly high build of 1.1 million barrels, against a forecast of a 1.3 million drawdown. Once again the devil was in the detail as gasoline and distillate inventories fell by 2.8 million and 2 million barrels respectively. WTI and Brent both spiked higher on the news initially, but then sold off sharply.

Investors have shrugged off talk of a fresh attempt by oil producers to agree to a production freeze. While this may be discussed when OPEC meets informally in Algeria in September, analysts don’t seriously think that an agreement can be reached. A similar attempt broke down in acrimony back in April this year.

Gold and silver flew higher yesterday as the US dollar declined. However, both metals pulled back from their best levels as the European close approached and as the dollar recovered. The dollar came under pressure following concerns that Monday’s weak US productivity data suggested that the Federal Reserve could hold off from tightening monetary policy until the end of the year. This was a sharp about-face after the greenback soared on Friday’s strong Non-Farm Payroll release. This came in well above even the most optimistic forecast, and was thought to increase the likelihood of a Fed rate hike at its next meeting in September.

This continues a pattern that has been playing out for some time now. Weak US data leads to a sell-off in the dollar (and a rally in precious metals) as the market rows back on its rate hike expectations. Strong data reverses the process. The stronger dollar makes it more expensive for non-dollar holders to purchase dollar-denominated commodities such as gold and silver. Weekly Jobless Claims number is today’s only important data release, but tomorrow brings US Retail Sales and the Producer Prices Index which are of far more significance. But the bottom line is that it’s unlikely the Fed will want to raise rates and risk a market sell-off ahead of November’s Presidential Election. However, that won’t stop speculation leading to big market swings.

Forex Update

The US dollar fell sharply yesterday as investors reassessed the outlook for future central bank monetary policy. This followed the release on Monday of weak US productivity data which suggested that the Federal Reserve could hold off from tightening monetary policy until the end of the year. This was a sharp reversal after Friday’s better-than-expected US Non-Farm Payroll release increased speculation that the Fed could look to hike rates as early as next month. On top of this, the euro was back in favour following the announcement that Spain and Portugal won’t be fined for failing to get their annual budget deficits back under the 3% limit.

The Japanese yen was one of the biggest beneficiaries of the falling dollar. This was particularly bad news for Japan’s policymakers who have tried repeatedly to push the currency lower. However, there was widespread disappointment that the Bank of Japan (BOJ) wasn’t more accommodative following its meeting at the end of last month. Matters got worse after Prime Minister Shinzo Abe provided details concerning his proposed 28 trillion yen ($277 billion) fiscal stimulus package which fell well short of market expectations. There were also concerns after the BOJ had said that they would conduct a “Comprehensive assessment” of its stimulus measures at its September meeting. There was speculation that the BOJ was preparing to end Quantitative and Qualitative Easing (QQE) package. This “QE on steroids” package has been a spectacular failure as it has done little to counter tepid growth and deflation. However, in what was seen as a pre-emptive action, the central bank suggested that it would not be considering any tapering of its stimulus programme. Unfortunately this did nothing to stave off such speculation and keep downside pressure on the yen.

Upcoming events

Today’s significant data releases include US Weekly Jobless Claims, Import Prices and Mortgage Delinquencies. Overnight we have Retail Sales from New Zealand.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: AM Bulletin


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