Markets convulsed at the end of last week after a weak GDP print in Germany and slowing industrial production data from China caused a flight to safety and an inversion in the US Treasury curve for the first time since 2007. From last Wednesday’s high print down to the Thursday low the S&P 500 moved down by over 4%. Then just as quickly stocks pared losses and were right back where they had started by Monday afternoon. Oil markets were largely along for the ride with the prompt Brent contract moving from $61 down to $58 before rebounding back to $60 on the same time frame.
The financial press and social media predictably touched both extremes in covering the chaos. On one side, the normal crew of financial apocalypse prognosticators saw the event as the beginning of the end of the global financial system as we knew it. On the other hand, a more bullish crowd suggested that the yield curve inversion was mere noise within the orchestra of the Trump administration’s economic miracle.
Now that the dust has mostly settled and markets are basically back where they started, we’re thinking both extremes are probably wrong. The truth is, global GDP and manufacturing data have been trending lower for most of 2019 and yield curves have been flattening in order to reflect the waning confidence among investors. Was one German GDP print of -0.1% really a shock? It shouldn’t be. Germany’s economy suffered a negative print in 3Q’18 and has been below 0.5% all year. Was China’s industrial production growth print for July of +4.8% a shock? Yes, it was lower than expected. But the index has been trending lower for two years and printed +5.0% just two months ago. Was the flat US yield curve a shock? The yield curve has been moving towards flat at warp speed for all of 2019 and government bond yields have fallen towards- and below- 0% in Europe and Asia.
We’re not arguing a flat yield curve and worsening economic data are good for the global economy. They’re not. But we do think the best way to interpret them is that they fall within the norms of a year-long trend of softening global economic data. This is certainly not a positive trend for oil prices and it should make bulls proceed with caution. However, the recent rebound in risk assets is consistent with our view that the Wednesday-Thursday meltdown of last week was an overreaction. We’re not feelingly rosy and bullish at this point, but the global economy doesn’t appear on the verge of apocalyptic meltdown either. Morgan Stanley’s Ruchir Sharma wrote lengthily on the subject of shrinking global growth in the New York Times this week in support of a thesis that we need to get used to slowing output as working-age populations shrink rapidly in China, Japan, the US and Europe. Maybe he’s on to something there.
The last time the US economy crashed aggressive Fed tightening and sky-high energy prices basically popped the bubble of excess debt. With the Fed now officially in retreat on rates and gasoline prices under control, it seems to us that the mostly likely scenario for the economy is to continue to slowly move towards lower growth rates rather than fall off a cliff. For oil traders it means that bulls need to be wary of the slowing global economy, but bears shouldn’t bank on a macro meltdown just yet either.
- Oil prices moved higher to start the week with Brent trending towards $60 while WTI traded $56. Both grades are lower by about $5 over the last four weeks as souring US/China relations and repeatedly poor data on global crude demand have poured cold water on OPEC+’s effort to tighten the market.
- Oil also received a boost from a Yemeni drone strike on a Saudi oil field this week. The field in question was Saudi’s Shaybah asset which produces about 1m bpd.
- Brent spreads have also tightened this week with help from continued output disruptions at Libya’s primary oil field.
- On the macro side, a persistently strong US Dollar has also been a thorn in the side of crude oil bulls. There has been a massive amount of news flow in the recent weeks covering the increasingly dovish US Federal Reserve. What this coverage seems to be ignoring, however, is that other central banks seem even more eager to ease financial conditions. The US Dollar Index was back within striking distance of its 2yr high this week near 98.3.
- In our opening piece, we mentioned that risk assets sold off massively last week before investors ultimately bought the dip and retraced the entire move. In bonds, however, the buying never stopped and the US 10yr yield actually sank below 1.50% for the first time in three years.
- Charts to the right also illustrate some of the economic data highlighted on our opening comment. German GDD growth for Q2 printed -0.1% on a Q/Q basis while Chinese industrial output for July gained just 4.8%. While both prints were weaker than expected and justifiably created anxiety in markets, the rebound of the following trading days suggests investors- at second glance- might not be overwhelmed with macro fears just yet.
- On a more positive note, there was a small thaw in US/China tensions this week when US Secretary of Commerce Wilbur Ross announced a delay of sanctions against Huawei.
DOE Wrap Up
- US crude oil stocks added 1.6m bbls last week and are higher y/y by 8%.
- Crude production as flat w/w at 12.3m bpd- just 100k bpd below its all-time high.
- On a more positive note, crude stocks in the Cushing, OK delivery hub took a sharp fall of 2.5m bpd to 44.8m bbls. Cushing stocks have dropped by 7.4m bbls over the last five weeks.
- The US currently has 25.5 days of crude oil supply on hand which is higher y/y by 9%.
- Traders imported 7.7m bpd of crude last week and exported 2.7m bpd leaving net imports at 5m bpd. US crude imports have averaged 7.1m bpd so far in 2019 while exports have averaged 2.8m bpd.
- Unfortunately, US refiner demand saw a massive tumble printing 17.3m bpd. Lower by 470k bpd w/w. US refiner demand has averaged 17.275m bpd over the last four weeks which is lower y/y by 310k bpd.
- Gasoline stocks fell 1.4m bbls last week to 234m and are flat y/y.
- US distillate stocks fell 1.9m bbls to 136m and are higher y/y by 11%.