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Early moves

- European equities drifting lower

- Crude oil steady after rallying on OPEC cut agreement

After a mixed start, European equities have begun to drift lower this morning. Now that the OPEC meeting is over, investors are looking ahead to tomorrow’s US Non-Farm Payroll number and the Italian referendum on constitutional reform on Sunday. In the meantime, today sees the release of a stack of Manufacturing PMIs from China, the Euro zone, UK and US.

So far, Brent and WTI are holding on to gains made yesterday when it became apparent OPEC had reached agreement over production cuts. The bulk of the rally was made ahead of the meeting following upbeat comments from Saudi Oil Minister Khalid al-Falih. However, there was widespread relief when the headline cut number of 1.2 million barrels per day (bpd) was later confirmed. Iran was allowed to freeze production at pre-sanction levels while Libya and Nigeria were exempted. In addition, Russia promised to reduce output by 300,000 barrels per day - half of the 600,000 bpd non-OPEC production cuts looked for in this new agreement.

But it feels as if we may have already seen the best of this oil market rally. There’s no doubt that there was some surprise that OPEC members (in particular Saudi Arabia and Iran) managed to bury their differences and come up with this agreement. However, it doesn’t start until next year and OPEC members are already pumping out product as fast as they can. In addition, there’s that all-important matter of ensuring compliance. On top of all this, a higher oil price is a gift for US shale oil producers. So perhaps we shouldn’t expect oil to rally much further from current levels.

Stock Index Update

- Equities boosted by OPEC agreement

- Also helped by decent data

European and US equities put in a strong performance yesterday. Investors responded to the rally in crude as it became apparent that OPEC members were set to reach an agreement over production cuts.

There was also some good news on the data front. Euro zone CPI rose 0.6% in November, suggesting that inflation in consumer prices is at its highest since April 2014. This may not be good news for consumers, especially as Euro zone unemployment remains high and wage growth tepid. Nevertheless, it is better news for the European Central Bank (ECB) even if inflation remains well below its 2% target.

Yesterday morning the Bank of England (BoE) released results of its banking stress tests which covered seven major financial institutions. RBS came up short on capital adequacy tests. However, it has already presented the BoE with a revised plan which was approved by the BoE’s Prudential Regulation Authority. The BoE’s stress tests also revealed shortcomings at Barclays and Standard Chartered although the report played these down saying the two banks had already taken measures to address any concerns.

On Tuesday the US Commerce Department released its revised third-quarter GDP number. This came in at +3.2% year-on-year which was better than the original +2.9% estimate. Consumer spending was the biggest contributor to growth while business investment was negligible. This could be a problem going forward as it suggests that this (tepid) economic expansion could be in its late stages.

Commodities Update

- OPEC agrees production cut

- Gold slumps as dollar rally resumes

Crude had its best session in 9 months yesterday with both WTI and Brent up around 8% at one stage. The rally came as investors waited for news from yesterday’s key OPEC meeting. Then early afternoon, with the meeting still in progress, there were reports that OPEC had overcome disagreements over exemptions and agreed to cut production by 1.2 million barrels per day (bpd).  This should take output down to OPEC’s production target of 32.5 million bpd which, conveniently, happens to be the forecast for global demand for OPEC output in 2017. Non-OPEC producers (led by Russia) still need to cut around 600,000 bpd to help rebalance the market. Later yesterday Iraq’s oil minister said that Russia had agreed to cut by 300,000 barrels.

But ensuring compliance is a potential problem. OPEC members have a very poor record when it comes to adhering to production quotas. In addition, any production cut plays into the hands of US shale oil drillers. Just the other week International Energy Agency (IEA) Director Fatih Birol told Reuters that oil prices could come under downward pressure even if there is a cut. He expects US shale oil producers to take advantage of higher prices to increase output.

Gold fell sharply yesterday and broke below support around $1,180. Silver also came under selling pressure although its losses were modest in comparison to gold’s. Both precious metals struggled in the face of a renewed rally in the US dollar. The problem is that investors are struggling to adjust from a market anticipating low growth, low inflation and low interest rates to one where the inflation genie may finally have been let out of the bottle. Certainly, the rally in the dollar and US equities appear to bear this out as there’s less reason for investors to hold precious metals as a safe-haven investment. In addition, the rise in the dollar means it’s more expensive for non-dollar holders to buy dollar-denominated commodities. Also, rising inflation expectations feed into higher yields. This means that non-yielding assets (such as gold and silver) lose their attractiveness.

Forex Update

- Dollar rally resumes

- USD boosted by oil and ADP data

The US dollar rose sharply against most of the majors yesterday. The only currency which managed to hold its own was the British pound. The Japanese yen and the euro were both hit particularly hard as traders readjusted their portfolios for the month-end. It was also interesting that the Canadian dollar (“Loonie”) was unable to hold on to early gains against the greenback, despite crude oil surging 8% at one stage yesterday. Typically, the Loonie is closely correlated with moves in the oil price.

The dollar got a lift as crude oil took off to the upside. OPEC managed to agree to a production cut of 1.2 million barrels per day and there is every indication that non-OPEC producers will reduce daily production by 600,000 barrels.

There was also good news on US employment. The ADP Payroll data for October showed an increase of 216,000 - well above the 161,000 expected. On the face of it this bodes well for tomorrow’s Non-Farm Payroll number. While there’s little direct correlation between the two data sets, typically a big “surprise” in the ADP is echoed in the official number. The only slight problem is that the prior ADP number was revised down by 28,000 jobs. Nevertheless, it tends to be the headline number that grabs investor attention.

Upcoming events

Today’s key economic data releases include Manufacturing PMIs from Switzerland, Italy, France, Germany, the Euro zone and the UK. From the US we have Challenger Job Cuts, Weekly Jobless Claims, the ISM Manufacturing PMI, Construction Spending and Total Vehicle Sales.

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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