Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
WCU: Oil rallies on Opec+ cut, gold breaks higher
Ole Hansen
Head of Commodity Strategy
Summary: A late agreement from the Opec+ group has driven prices of Brent crude up by 5% while gold is rallying in response to a soft US jobs print.
Commodities found a bid on Friday to finish the week higher after the Opec+ group – following 24 hours of negotiations – agreed to a production cut large enough to support the market. Gold, meanwhile, traded above $1,240/oz in response to a weaker than expected US nonfarm payrolls report.
Until Friday, the market had been struggling amid continued worries about the economic impact of the ongoing trade war. US and global stock markets gyrated wildly with the trade war and flattening yield curve raising the risk of a US slowdown.
While the interest rate market was busy pricing out the risk of further US rate hikes in 2019, Federal Reserve chair Jerome Powell delivered a bullish assessment of the economy, saying in Washington that “our economy is currently performing very well overall, with strong job creation and gradually rising wages.’’
This was before the monthly jobs report for November yielded a smaller-than-expected rise in new jobs while hourly earnings remained unchanged at 3.1%.
President Trump’s tariffs have yet to positively impact US trade with the rest of the world, and the October deficit rose to $55.5bn, a 10-year high, not least due to record imports from China and lower exports on the strong dollar and trade war uncertainty. The ISM non-manufacturing index, meanwhile, climbed to its strongest since 1997 (three-month average) before the slightly disappointing jobs number.
The Bloomberg Commodity Index traded higher for a second week with gains in crude oil, precious metals and grains offsetting losses in natural gas and some industrial metals.
Until Friday, the market had been struggling amid continued worries about the economic impact of the ongoing trade war. US and global stock markets gyrated wildly with the trade war and flattening yield curve raising the risk of a US slowdown.
While the interest rate market was busy pricing out the risk of further US rate hikes in 2019, Federal Reserve chair Jerome Powell delivered a bullish assessment of the economy, saying in Washington that “our economy is currently performing very well overall, with strong job creation and gradually rising wages.’’
This was before the monthly jobs report for November yielded a smaller-than-expected rise in new jobs while hourly earnings remained unchanged at 3.1%.
President Trump’s tariffs have yet to positively impact US trade with the rest of the world, and the October deficit rose to $55.5bn, a 10-year high, not least due to record imports from China and lower exports on the strong dollar and trade war uncertainty. The ISM non-manufacturing index, meanwhile, climbed to its strongest since 1997 (three-month average) before the slightly disappointing jobs number.
The Bloomberg Commodity Index traded higher for a second week with gains in crude oil, precious metals and grains offsetting losses in natural gas and some industrial metals.
The focus all week was the Opec and non-Opec summit in Vienna. Just a few months ago, we would have expected these meetings to represent a celebration of the group’s success in lifting oil prices. Instead, and just as in 2016, the cartel and its friends have once again been forced to find a painful compromise on how to stem the collapse which has seen the price drop by 30% since early October.
Following two days of intense discussions, the Opec+ group announced a combined cut of 1.2 million barrels/day. This came as a relief for the market, which had feared a cut no higher than 1 million b/d. It had been feared that Saudi Arabia, under pressure from President Trump to pump and following the Khashoggi murder in Istanbul, would struggle to come up with a cut big enough to satisfy the market.
In the end, they succeeded in putting a floor under the market, which responded by sending Brent crude higher by more than 5% following the announcement.
Following two days of intense discussions, the Opec+ group announced a combined cut of 1.2 million barrels/day. This came as a relief for the market, which had feared a cut no higher than 1 million b/d. It had been feared that Saudi Arabia, under pressure from President Trump to pump and following the Khashoggi murder in Istanbul, would struggle to come up with a cut big enough to satisfy the market.
In the end, they succeeded in putting a floor under the market, which responded by sending Brent crude higher by more than 5% following the announcement.
Brent has managed to establish some support after almost giving back half of the gains seen since the early 2016 low. We believe that the 1.2 million b/d cut should provide solid support. The continued removal of Iranian barrels over the coming months, combined with US production growth potentially slowing in response to the recent collapse, could see Brent crude make its way back towards $70/b during the coming weeks .
Just like 2014 when prices collapsed, it is the continued impact of surging US production that is putting pressure on Opec and Russia. During the past year, production has surged by more than 2 million b/d; last week, this resulted in the US becoming a net-exporter of crude oil and products for the first time in 75 years.
While this is not expected to become the new norm just yet, it nevertheless highlights the continued change the US shale oil revolution has brought about during the past decade.
Just like 2014 when prices collapsed, it is the continued impact of surging US production that is putting pressure on Opec and Russia. During the past year, production has surged by more than 2 million b/d; last week, this resulted in the US becoming a net-exporter of crude oil and products for the first time in 75 years.
While this is not expected to become the new norm just yet, it nevertheless highlights the continued change the US shale oil revolution has brought about during the past decade.
Note: The final details and President Trump’s response to the deal were not yet known at the time of writing.
Gold was heading for its best weekly performance since August as it traded above previous resistance at $1,240/oz. Support has been provided by a weak jobs report for November, ongoing uncertainty on trade, stock market gyrations, lower bond yields and the reduction in rate hike expectations into 2019.
The 30% collapse in crude oil prices since early October has helped remove some of the inflationary pressure and with that, the need for much higher US short-term rates. Last week, Fed chair Powell said that the Fed is getting closer to what it perceives as being a neutral rate, i.e. not too tight and not too easy. The reaction to this has been a continued reduction in the market's expectation for future rate hikes.
Additional support for gold has emerged through the renewed strength in bonds and not least the accelerated flattening of the yield curve – something that in the past has signalled an increased risk of an economic slowdown in the US.
The two- to 10-year spread, which is closely watched as a potential indicator of an emerging recession, has flattened to just 12 basis points, primarily driven by a drop in US 10-year yields to a three-month low of 2.88%. Finally, the slightly weaker dollar, especially against the Chinese yuan, has provided an additional source of support, particularly given the high correlation seen between gold and this currency in recent months.
Gold was heading for its best weekly performance since August as it traded above previous resistance at $1,240/oz. Support has been provided by a weak jobs report for November, ongoing uncertainty on trade, stock market gyrations, lower bond yields and the reduction in rate hike expectations into 2019.
The 30% collapse in crude oil prices since early October has helped remove some of the inflationary pressure and with that, the need for much higher US short-term rates. Last week, Fed chair Powell said that the Fed is getting closer to what it perceives as being a neutral rate, i.e. not too tight and not too easy. The reaction to this has been a continued reduction in the market's expectation for future rate hikes.
Additional support for gold has emerged through the renewed strength in bonds and not least the accelerated flattening of the yield curve – something that in the past has signalled an increased risk of an economic slowdown in the US.
The two- to 10-year spread, which is closely watched as a potential indicator of an emerging recession, has flattened to just 12 basis points, primarily driven by a drop in US 10-year yields to a three-month low of 2.88%. Finally, the slightly weaker dollar, especially against the Chinese yuan, has provided an additional source of support, particularly given the high correlation seen between gold and this currency in recent months.
The uptrend in gold that was established after hitting a low point in August and following the break above the October high may now attract additional short covering from hedge funds who have been holding a net-short position since July. Reversing that back to a long position, outside market developments permitting, could help trigger an extension towards the next levels of resistance at $1,262/oz. and potentially as high as $1,286/oz.
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