Archive for September, 2016
It was obvious at the start of this year that the behaviour of the oil price would be one of the key economic variables of 2016. We saw sharp falls early on, with lows below $30 repeatedly tested. (Had these persisted the disinflationary impact of cheaper energy would have continued into the winter.) Then there was a convincing recovery, along with risk assets, into the spring. And over the past few months the price has stabilised convincingly for the first time since the initial fall in 2014, holding a range of about $45-50 since the middle of April.
This week’s OPEC meeting might be expected to reinforce that stability. The decision was announced on Wednesday to reduce the cartel’s crude output by about 0.25m-0.75m barrels per day. (Details of individual production quotas are to be agreed at the next meeting in two months’ time.) There are the usual question marks over the credibility of the OPEC system – diplomatic tensions between its members, doubts as to their adherence to quotas in the first place and so on. Crude has fallen back a bit today on profit taking and on fears that the deal, modest as it is, might yet fall through.
But the announcement was significant. It is the first cut agreed since 2008. Should November’s meeting prove fruitful the group’s quotas will have changed for the first time in five years. It has encouraged Russia to start talking about a production freeze again. It hints, in short, at the firming of the bottom end of the range we have seen oil prices occupy over the last five months.
This is doubly true when we look at recent changes in the balance between crude supply and demand. Over the course of 2014, the six-monthly average global production level increased by 2.8m bpd as against a 1.1m bpd increase in demand. Albeit on a much lesser scale the reverse has happened since: six-monthly average global demand has risen by 2.3m bpd versus a 2.0m bpd increase in supply. In fact the production surplus as of August, again using the six-monthly average, had fallen to 443k bpd down from a high of over 1.5m bpd in mid-2015. So the OPEC cut, especially if accompanied by a Russian cap on output, would bring supply consistently below the level of aggregate demand for the first time in over two years.
Looking at this from the other end, rising prices would come under pressure from increased production from other sources, notably US shale. Cost efficiencies have already seen the oil rig count rise by 32% from the low it reached back in May – and it remains way off the mid-2014 highs. The current range for crude, then, would appear to be secure both from persistent falls and persistent increases. It could be a case of 2012-2013 all over again, just at the $50ish per barrel mark rather than $110.
There we must add a note of caution. For some producers, $50 per barrel is too low. OPEC granddaddy Saudi Arabia has just had to funnel billions of dollars worth of state support into its banking system. Its reserve assets peaked at $731bn back in 2014 (about 100% of GDP – quite a cushion). Since then they have fallen by almost a quarter to $553bn. That’s a sharper fall than Russia has seen over the same period (-15%. Indeed, Russian reserves have been climbing steadily for more than a year). At the extreme end of the spectrum, there is the bitter human tragedy unfolding amid the ruin of Venezuela. The fall in crude has not killed off shale, but it has put several economies under varying degrees of strain. If there is a real challenge to the OPEC deal this blog suspects that it will come about from economic imperatives rather than political disagreement.
Deal or no deal, oil seems to have found its level more securely than ever now. Regular readers will know what this means for inflation, and, depending on the reaction function of the central banks concerned, monetary policy in due course.
Think “political risk in Europe” this year and you would most likely have thought about the Brexit vote. It is of course true that Britain faces an uncertain future, and that Brexit will have consequences for the EU too. But it is far from the only game in town.
On Sunday week the electors of Hungary will cast their votes in a referendum on the issue of migrants. Specifically, they are being asked if they accept the EU’s allocation of a migrant quota to Hungary without the consent of their national parliament. The most recent opinion polls suggest that anywhere from three to four percent of citizens are inclined to vote, “yes”. Barring a miracle, Hungary is about to throw down the gauntlet to Brussels in a few days. This has already appalled one or two other EU members: Luxembourg’s most senior diplomat has called for Hungary to be expelled from the Union altogether. In response the Hungarian government is calling for treaty change (specifically reform of the constitutional Treaty of Lisbon).
The question for investors, of course, is: will markets care about this? Even if Hungary were to leave the EU it isn’t in the euro and is a smallish country, so the answer, in isolation, is almost certainly “no”.
It is equally obvious, however, that the Hungarian vote is not an isolated incident. Portugal was talking about a Greek-style referendum on bailout terms over the summer, though this has yet to amount to an actual plan (and didn’t do Greece herself any good in the event either). And next week the Italian cabinet is to fix a date for a referendum on constitutional reform. The detail here is extremely boring but Prime Minister Renzi staked his political future on the outcome. He has tried backsliding on his promise this week but by turning the referendum into an effective vote of confidence in his government it is being seen as a conduit for Italian euroscepticism. This has gained sufficient strength for the Five Star Movement – an anti-establishment party founded by a comedian which sits in the same group as UKIP in the EU parliament – to be leading the polls. “M5S” does not actually want Italy to leave the EU – but it does want a referendum on the euro. In the meantime opinion polling suggests that the constitutional referendum is balanced on a knife edge.
Will rising Italian euroscepticism, or at least anti-euro feeling, present a challenge to the markets’ confidence? Not in isolation perhaps . . .
The Italian situation might well be complicated further should neighbouring Austria elect Norbert Hofer of the Freedom Party to be her president this December. Mr Hofer, who is currently in a dead heat with his Green Party opponent, once called for the border with Italy to be changed and the province of South Tyrol to be incorporated into his own country. Be that as it may he certainly wants to close the Italian border to migrants. And there is more: the last time the Freedom Party came into power (as part of a coalition in 2000) the EU imposed sanctions. Would they do so again?
Looking to the new year, the Netherlands will hold elections in March. There, another party with “freedom” in its name is topping the polls and its leader, Geert Wilders, once banned from entering the UK for his views on Islam, could end up as premier. He and his party want out of the EU.
Soon after the Dutch it is the turn of the French to vote for their president. Marine Le Pen, leader of the National Front, is almost certain to wind up in the second round vote, probably against a centre-right opponent. Like her father in 2002 she will almost certainly go on to lose, but her share of the vote will be interesting. The National Front is, as its name suggests, a nationalist party and has always opposed the existence of the EU.
Then, at around this time next year, we will have the Germans. The migrant crisis has propelled support for a new eurosceptic party, the Alternative for Germany (AfD) to 16% in the polls. It has been winning seats in regional elections. It looks set to establish itself firmly as Germany’s third party come next autumn. Some of its members have an enthusiasm for Nazi memorabilia and have defended some of the actions of Hitler’s government. The party has not yet advocated EU withdrawal, but it was founded to bring back the Deutschmark and stop Germans having to bail out other member states. It is also implacably opposed to immigration, effectively opposed to the idea of the Schengen area and overtly anti-Islamic.
Again, it is possible that the EU and the euro will muddle through all this. France and Germany are not going to elect eurosceptic governments, yet. Wilders’ lead in Holland is not unassailable – and the collaboration of his main opponents could, in theory, keep his party out of power anyway. It is impossible to predict these things but it does seem unlikely that the single currency will be seen to be facing as much of a threat over the next twelve months as it was seen to be facing at the nadir of the sovereign debt crisis in 2011.
The risk, however, is there.
Apart from the voting calendar there are simmering tensions to consider within the EU bloc. Perhaps most serious among these is the stress caused by the migrant crisis. The “Visegrad Group” comprising Czechia, Hungary, Poland and Slovakia submitted a list of
demands proposals at the Bratislava summit last week which included flat opposition to mandatory migrant quotas. The EU is at loggerheads with Hungary and Poland over constitutional issues; meanwhile the Polish and Hungarian leaders are extremely close allies who hold frequent bilateral meetings. This is a barrier to sanctions which some in the EU would like to impose on Poland. (It is seen as a lesser problem that the current Polish government swept to power last year with the first absolute parliamentary majority since the restoration of democracy in 1989.)
Of course there are external issues to consider too, most notably relations with Russia and Turkey. Even more widely, the Brexit vote, support for Donald Trump in the US and the threat of the Philippines to pull out of the UN among other things might suggest that supranationalism as a concept is struggling at this point in history.
But we don’t need to worry about that. There is quite evidently enough within the EU to worry us already.
In isolation, none of these risks appears to pose much of a threat to the bloc or its currency. Importantly, the result of this is that such risks are no longer remotely priced in. Given what we know about the political calendar over the next twelve months it is hard not to conclude that this represents too high a level of complacency.
At this time last year, markets were preoccupied by the bear case on China. The stock market had collapsed, the yuan was devalued and the country stood supposedly on the brink of a major banking crisis brought on by bad lending and vanishing growth. So appalling were the consequences of such a crisis that the Fed explicitly linked US monetary policy to the wild ride offered by the Shanghai Stock Exchange.
What a difference a year makes! There is the occasional susurration over the Chinese Peril discernible by those who listen intently, but panic on the subject, having waxed to hysteria last summer, has since waned to nothing.
At the same time, Chinese data has continued to be published as before. So what has it been telling us? Are we being complacent to ignore a threat which only twelve months ago was thought to imperil the world? Or was it all nonsense?
A year ago this blog took something of a sceptical stance on the Chinese Peril. On the subject of devaluation in particular we said that “exports matter to the Chinese economy, devaluation ought to help exporters, and monetary softening elsewhere ought to ease some of the pain in the property market and contribute to lending growth.”
Lo and behold, those macroeconomics textbooks turn out not to be a waste of shelf space after all. Trade figures out from China yesterday showed the pace of decline continuing to slow; both export and import numbers exceeded forecasters’ expectations. It is instructive too that the latest bout of renminbi weakness has passed without much comment: the yuan is just under 3% weaker against the dollar for the year to date, almost matching the pace of its decline last year when it made for headline news. (Just as importantly it is also 6% weaker against the euro and 21% weaker against the yen.) So far there is no sign of this translating into higher prices: CPI inflation was +1.3% on the year to August, towards the bottom of its recent range and well below the levels of 5-6% which provoked a policy response in 2010-11.
Further evidence of economic woe last year came from output indexes. It was seen as more surprising than it should have been at the time that a sharp strengthening of the currency had hurt manufacturing. Similarly, when last week’s manufacturing PMI number came out at 50.4 for August – not earth-shattering, but the highest level for two years – it not only beat expectations but fell outside the entire forecast range.
Another area of concern was the property market. Signs of weakness last year were misinterpreted as a dangerous, balance-sheet-threatening bubble collapse. Yet the market has since steadied following its correction and some cities are imposing ownership curbs in an effort to curb precisely the kind of overextension which so many observers thought they had noticed twelve months ago. As to balance sheets, figures out last month showed that the bad loan ratio for the Chinese commercial banking system actually stabilized in the second quarter at 1.75%. (That’s still a large figure in dollar terms – $215bn – but then China has fifteen times that amount in sovereign reserves.)
Looking at some other indicators, retail sales growth has remained steady at levels of +10% on the year and more throughout 2016, and July’s passenger car sales figure (+26.5% on the year) was the highest posted for three and a half years. On the industrial side of things, electricity consumption came in at +8.2% on the year to July, up from -0.2% back in December and the highest print since February 2014; headline industrial production itself seems to have bottomed out last year and has turned out at +6% and better for 2016 so far.
None of this is to say that China does not have her economic issues, like every other country. Here one might think of SOE inefficiency, frustrations to some monetary transmission mechanisms, over-reliance on particular sources of growth, grim demographics and developing world problems such as questionable building standards and the frictional effects of political corruption. But if we are to find the source of the next global catastrophe it seems we must look elsewhere. The Chinese Peril, if such a thing really exists at all, is still biding its time.