20 July 2020
China is now being hit by its worst floods in decades. And Covid-19 virus cases are surging in a number of major US states.
We focus on Brent as the global benchmark.
The market closed up $0.50/bbl at $43.13, virtually unchanged from the previous week.
Prices continue to operate in the very narrow ‘flag shape’ shown in the chart. This is typical of a market preparing for a major move – as we forecast on 1 March based on a similar flag shape, when suggesting correctly that:
“Oil prices (then at $50/bbl) seem highly likely to soon be back at their long-term average, below $30/bbl.”
The flag shape is a sign that the bulls and the bears have battled each other to exhaustion.
At first, the market saw a steady upward rise, as it rallied strongly from April lows. But since June, momentum has slowed, with prices moving in cents per barrel, not dollars. It is also clear that prices face major headwinds:
- The vast inventories built up during Q2 have still to be unwound – US distillate stocks are 26% above their 5-year average
- US gasoline demand growth has also stalled as lockdowns are imposed/reimposed
- Whilst in China, the catastrophic floods are starting to have a major impact on the economy.
One measure of the reversal is that the US is close to becoming a net exporter of oil again. Prices have risen high enough for many shale wells to reopen, whilst demand growth is slowing.
We focus on the US S&P 500 Index as the world’s major stock market index.
The market shows a similar pattern to Brent, moving in an ever-narrowing range since June to close on Friday at 3224. As the chart shows:
- It took off like a rocket in March when Federal Reserve stimulus cash was announced
- It was given a second wind when frustrated sports betters started gambling stimulus cheques on Hertz and other bankrupt stocks
- But bubbles need more and more air to keep being pumped in, and since June the market has stalled
Congress returns this week, and will no doubt agree to maintain some form of stimulus payments, given that lockdowns are not ending as expected. But whilst this will be good news for furloughed employees, it won’t help the thousands of businesses who are seeing demand disappear again.
We focus on the US 10-year rate, as this is the “risk-free” benchmark for global markets.
The rate closed down 0.01% at 0.62%, having traded in a narrow range between 0.57% – 0.65%.
Interest rates continue to be “the canary in the coalmine” warning of further problems ahead. Typically, bond markets are more in touch with reality than stock markets, as the role of passive and high frequency trading is lower. Large bond funds often still carry out their own research, rather than relying on “tips” from the sell-side.
And as the chart shows, bond investors have never bought seriously into the concept of a V-shaped recovery, which has driven the rallies in oil and stock markets. They toyed briefly with the idea in early June, when rallying to 0.95% – but quickly fell back again.
China floods and US lockdowns
Further major disruption is underway in the world’s two largest economies as the charts confirm:
- Large parts of China are suffering from the worst floods in decades, causing massive disruption all along the Yangtze river
- Wuhan, the epicentre of the Covid pandemic, has been badly hit, and the Three Gorges Dam has been 15m above its flood limit
- Large parts of the USA are seeing a rise in Covid-19 cases, with the total of new cases reaching 70k/day
- Florida now has more daily cases than any European country at the height of the pandemic
China’s floods have been building since May, and look set to badly impact the economy over the next few weeks, just as it was starting to recover from the Covid pandemic.
US lockdowns had been easing, but now an increasing number of state officials are having to reimpose restrictions, or impose them for the first time.
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pH Outlook team
Paul Hodges is a Global Expert with the World Economic Forum: he speaks regularly at international conferences and writes for the Financial Times.
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Daniël de Blocq van Scheltinga Is Hong Kong-based with a background in investment/ corporate banking; he was the first foreigner to run an SOE’s finance department in China.
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David Hughes is an expert on the Middle East, and worked in Saudi Arabia for 5 years.
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Paul Satchell understands financial markets, having been an equity analyst with several leading investment banks.
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