The CORRECTION: We’ve all awaited it and I’ve been loath to call it, but too many factors have rolled in at once and its time has come. Oil will show the way on the extent of this correction, but my guess it will be relatively shallow, but take a rather long time. Batten down the hatches.
Too many negatives have hit the markets at one time – and finally, the markets can no longer ignore them all and continue to roll forward. The latest round of sanctions against Russia will slow Russian oil production, weaken the global economy and certainly inspire Russian retaliation in Eastern Europe. The new ‘Cold War’ is beginning and will not be fought through an arms race, but rather by jabbing economic daggers from West to East and vice versa.
Add that dangerous concept to two more: Argentina’s decision to default and rising interest rates.
While most have been nonplussed by the prospect of an Argentinian default, the long-term results could be quite disastrous for global credit markets. It is not just the ‘anti-law’ stance that the Argentinian government has taken to the rulings by a US judge, US Supreme Court and International arbitrator, offering only an exchange of bonds to sovereign bond holdouts in a last ditch effort to avoid this default. By, in essence, refusing to recognize these legal rulings, a new era for all sovereign debt funding may be beginning where rates on all foreign denominated bonds priced in dollars will have to be significantly higher to attract investors.
What happens when the rates for all sovereign debt goes up? All economic growth suffers. This Argentinian bond default is not like the other 7 they’ve experienced, because of the nature of the bondholders on the other end. More bad news.
And the Treasury markets in this country are reacting strongly and negatively. Despite continued pressure from the Federal Reserve on short-term rates, 2-year treasuries have been falling and the curve in rates has been flattening. This indicates an even more worrying thought that the markets are beginning to believe that the Fed has lost control of interest rates, much more important than the idea that the Yellen schedule for tightening is either slow or fast.
Circle back to oil now. With so much geopolitical risk on the table, it’s hard to imagine oil now dropping under $100 a barrel. And the risks will ultimately translate into a supply shortfall and a recovery for oil prices. There might be an opportunity in this knowledge, but remember to recognize that the short-term trend is on a full asset correction, and oil won’t be spared. If the stock market indexes continue to fall and give back the 7-10% of gains that everyone seems to believe is inevitable, oil cannot possibly rally in it’s face.
However, there are numbers in the oil markets to be aware of. I still believe that you will not see a lower low than last year, meaning that $94 is a serious line in the sand for oil. While that leaves relatively little room on the downside, it goes to extend my thoughts that this ‘correction’ will be shallow, but could last quite a long time – perhaps even into the end of the 4th quarter of 2014.
Batten down the hatches.