The Daily Dose

A recent headline from the Wall Street Journal put crude oil in a bear market on demand fears emanating from the outbreak of the Wuhan coronavirus. A bear market is defined as a 20% contraction from recent peaks, which would put the high-water mark somewhere around early January when Brent was near the $69 per barrel range. Later, the Journal’s editorial board suggested that contagion has set in.

“U.S. manufacturers such as Ford, Apple and Tesla have temporarily halted production. One-sixth of Apple sales and nearly half of chip-maker Qualcomm’s revenues come from China. So do 80% of active ingredients used by drug-makers to produce finished medicines. Because China is the world’s largest manufacturer and an enormous consumer market, the economic freeze will disrupt supply chains and reduce corporate earnings,” editors wrote.

When China coughs, the rest of the world catches the cold, the editors added. Chevron last week turned in disappointing results for the fourth quarter, but indicated that total liquid fuel production had increased, driven in large part by US shale. On Tuesday, British supermajor BP raised it dividends, but reported a loss for the quarter. Shares of BP were up more than 4% in early Tuesday trading on the news.

Elsewhere, OPEC delegates are meeting in Vienna to consider their response to the demand destruction supposedly triggered by the coronavirus. If we follow fourth quarter reports from the likes of Chevron, and consider the steady gains in US inventories, OPEC may have a case to cut deeper. Rumors surfaced Monday that Saudi Arabia was pushing for cuts equivalent to sidelining a fully-producing Libya from the market. But on Tuesday, Russian Oil Minister Alexander Novak said it may be premature to take formal action.

“There are lots of uncertainties, maybe those are panic attacks,” he said.

Indeed, there may be some scapegoating of the coronavirus. Fourth quarter woes from energy companies reporting thus far are reflecting a market already under pressure from US-Chinese trade tensions and manufacturing weakness. The first quarter, meanwhile, is typically a quiet one, leaving the door open for the amplification of even a minor market shock. 

In US politics, a glitch delayed the outcome of the Iowa Caucuses. Left-leaning Bernie Sanders reported that internal figures showed he was the winner, though Pete Buttigieg was also upbeat on the results. For the markets, a Sanders win may be unsettling to some given his campaign pledges of breaking up big banks, increasing taxes on the wealthy and hiking the minimum wage. If his internal figures are accurate, the market could move into the red in response. The SNAFU alone, meanwhile, is sure to give President Trump ample ammunition to fire at his rivals. 

Crude oil prices were in the black at the start of the trading day, though expect OPEC rumors to make for a bumpy ride. Uncertainty from the cartel could spoil the rally. Later, the American Petroleum Institute releases its data on US crude oil inventories and any signs of continued glut could drag on prices. Intra-day patterns on Brent were noisy on Tuesday and expect the volatility to continue.

Scapegoating Demand Destruction

Risk level: Orange

RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)

THE BOOSTER SHOT

•           Demand concerns predate the coranovirus.

•           OPEC needs a Goldilocks moment.

Chinese refiners on Monday hinted they were cutting throughput amid demand concerns stemming from the outbreak of the Wuhan coronavirus. Fears of the spread of the novel coronavirus, 2019-nCoV, were blamed for the precipitous collapse in crude oil prices in January and those fears have turned into reality to some degree. According to the IMF, the outbreak is expected to put pressure on a Chinese economy already bruised by simmering trade tensions with the United States. The coronavirus has also attracted the attention of OPEC, though further restraints may not be warranted over the long term. First quarter decisions will certainly be impacted by the spread of the virus, though caution should be in vogue.

Demand concerns, both real and imagined, led to sharp sell offs in January, with Brent retreating further and further away from the $60 per barrel mark. The post-holiday malaise had already curbed the appetite for oil, and quarterly figures from some of the world’s biggest oil companies were disappointing. Brent closed the week down 4.2% to end at $58.16 per barrel.

Exxon Mobil last week reported first quarter earnings of $5.7 billion, down 5% from the same period last year. Annual revenue for 2019 was some 31% lower than the previous year. Output from the upstream segment, however, came in on the upside. The company is at the tip of the spear in getting oil out of Guyana and said fourth quarter liquids production was up 4% year-on-year, driven largely by output from the Permian basin in the United States. That production growth came during a fourth quarter that saw economic constraints emanating from the US-Chinese trade war, showing the market was already tilted toward the surplus. 

The demand destruction had already caught the attention of OPEC, whose members are meeting later in the week to consider their reaction to the coronavirus. The obligatory sources say Saudi Arabia may be coming to the table in Vienna with calls for big, but perhaps, temporary cuts to balance the market. But to pin the blame on the outbreak of the coronavirus is misguided. Demand constraints were an issue during the fourth quarter as the manufacturing sector in particular faced headwinds because of the trade war and the rising price for steel. By most accounts, manufacturing is in recession. In the shale belt, meanwhile, lower oil prices are taking a toll. Keith Phillips, an assistant vice president at the Federal Reserve Bank of Dallas, said the state’s economy will likely outpace the nation this year, but there were underlying concerns.

“The biggest downside risks to forecast are a sharp decline in oil prices, trade war escalation or a national recession,” he said.

It is easy to pin the blame on the coronavirus, though it is scapegoating to some degree. Dallas Fed concerns about recession predate the latest health concerns, though those concerns are making an impact, though the impact is to some degree emotional. Unlike a war on distant land, health concerns are related more directly to personal welfare. That can influence consumer behavior and compound the demand issues, particularly for fuels, as travelers stay home. Those, however, are short-term factors and do little to explain market malaise from the fourth quarter. Figures like GDP and segment employment are backward-looking indices, so are more reflective than predictive. Earnings reports offer something of a better view of the road ahead, and those reports have focused on more concrete concerns like trade. The IMF last week said that while there will be some economic issues stemming from the coronavirus, it is “too early really to quantify in any precise way the economic impact.” That sentiment should be considered by producers and corporations alike. Already, there are talks of sidelining as much as a million barrels per day in production in order to arrest the decline in the price of oil. Speaking to CNBC on Monday, Helima Croft, the head of commodities at RBC Capital Markets, said it is a “go big or go home moment” for OPEC. Any knee-jerk reaction, however, is risky, leaving the market vulnerable to mistakes. Too big, and the market pressure could disrupt economic growth even further. Too little, and OPEC looks blasé or even irrelevant. What’s necessary in the current market is a Goldilocks moment where cooler heads prevail.

We are still in earnings season, so pay attention this week to sentiments from the likes of BP. The Iowa Caucasus will also impact the market, particularly if left-leaning Bernie Sanders or Elizabeth Warren pass former Vice President Joe Biden. The reading on US manufacturing on Monday will certainly factor into the trading day, particularly if it misses. Construction spending is already expected to show a contraction. ADP payrolls for January are out on Wednesday, as is the usual EIA data. OPEC meetings later in the week, however, will be the main factor to watch. A cut of some sort is expected, so another Orange alert is in force for the week, with Brent expected to swing by at least +/- 3%.

Risk level: Yellow - Elevated

RED: Severe (+/- 4%) ORANGE: High (+/- 2%)  YELLOW: Elevated (+/- 1%)  BLUE: Guarded (+/- ½%)

THE BOOSTER SHOT

•             McCain's vision of a U.S. beacon is under threat from the Trump administration.

•             A threat to leave the WTO is a forfeit of the liberal order the U.S. designed.
•             Development, according to Henry Kissinger, requires a "spirit of cooperation."

This week's narrative was driven by the U.S. political meaning of the death of Sen. John McCain. In some ways, it marked an end of an era in American politics. Delivering his eulogy, former Vice President Joe Biden said the Arizona senator "understood that America was first and foremost an idea." And that idea is changing. With a Mexican trade proposal on the table, President Trump turned his ire toward Canada, which has one of the most comprehensive defense arrangements and $1.7 billion in daily bilateral trade with the United States. Later, the president suggested he would pull out of the World Trade Organization, an organization the United States helped design. Perhaps after decades of management fatigue, it's understandable for the U.S. government to seek some sort of new leadership configuration. But any drastic change in the rule-making mechanism of global order is disruptive to the entire international system. Trump's decisions have consequences that extend beyond his myopic commitments to campaign-trail pledges. Hegemony comes from the ability rather than desire. In a note to clients this week, J.P. Morgan said "something will give" and we wonder what that dropped shoe will look like in economic terms.

For Sen. McCain, the former vice president said, the United States was "the world's last best hope [and] the beacon to the world." And for the decades after the indoctrination of The Marshall Plan, that was largely true. Through the post-WWII reconstruction effort, the United States was able to undermine the appeal of the Soviet Union while at the same time integrating the economies of Western Union into its sphere of influence. The world order that emerged out of the 1940s was one of liberalism; the idea that order comes through rule-making regimes and cooperation. The international system under this order is a non-zero sum game that's played over many rounds, rather than one single turn. Since the end of World War II, this international system was bound to U.S. hegemony, as it was the only power in the system with the capacity to lead.  Since the end of World War II, the international system was largely a U.S. creation. Integration is now taboo as President Trump seeks to dismantle a system that was largely of U.S. design.

"If they don’t shape up, I would withdraw from the WTO," Trump told Bloomberg News on Thursday.

Evolved from Bretton Woods, the WTO is largest international economic organization in the world. The aim of interdependent mechanisms like the WTO is to coordinate parties around a core group of rules and, ultimately, shared interests. With power concentrated around the United States and Europe, management of this system becomes easier because of the capabilities of the major players.  Management also gives the major powers greater control over how the game is played. But as obligations accumulate for the lead powers, management becomes a burden. Former Secretary of State Henry Kissinger addressed this concern in 1974 not with a determination to back away from the burden, but with a determination to take the challenge on directly.

"Development requires, above all, a spirit of cooperation," he said.

Rather than cooperate collectively, the Trump administration aims to reshape U.S. relations in a one-on-on, round-by-round fashion. Kissinger wrote that, whatever the ideological belief, all nations are part of an international system and all nations are therefore interdependent and liberal. Under the realist tradition embraced by Trump, a tradition that pits every man against every man, the game is zero-sum and it's uncertain which pole in the global balance of power losses out.

Canadian Foreign Minister Chrystia Freeland said she's hoping for a "win-win-win" arrangement on North American trade. Brushing off comments by the president (and perhaps brushing off the president himself), the Canadian minister said her negotiating partner wasn't Trump, but U.S. Trade Rep. Robert Lighthizer. Trade talks are set to resume next week and we wonder about the energy implications. Chapter 6 of the North American Free Trade Agreement prohibits direct government intervention in the energy markets, either through export taxes are direct disruption of supply channels.  Without NAFTA, the price for Canadian crude oil to the United States could jump. With even a 10 cent per barrel increase, that would cost the U.S. economy an extra quarter million dollars or so per day. That's a zero-sum loss for the United States, which imports most of its crude oil from Canada. Meanwhile, Canadian producers are already looking to markets outside of North America for oil customers, though Canada faces its own problems in approving new infrastructure.

There could be tailwinds for the price of crude oil given the latest 4.2 percent annual rate increase for U.S. real gross domestic product in the second quarter. But a more careful look in the government data found real GDP increased sequentially 1.8 percent, compared with a 3.9 percent increase in the first quarter. Meanwhile, core PCE inflation hit the U.S. Fed target of 2 percent, but that may be the peak given some curve-based predictions of a slowdown next year. Against that data, meanwhile, is the consistent threat of the loss of Iranian barrels at time when U.S. holiday travelers are paying the highest retail gas prices in four years. That too is a zero-sum loss.

Next week could be a down one for the price of oil as it's expected the Trump administration will hit China with another round of tariffs. Meanwhile, Canadian negotiators look to Wednesday as a pivotal day for multilateral trade.  Monday is a federal U.S. holiday so trading will be light. Tuesday gets off with a bang as the Institute for Supply Management publishes both its U.S. manufacturing and employment survey. We may get a peek inside Canadian economic thinking with a rate decision on Wednesday, which will also be a key market day with EIA inventory figures. And it's big-data Friday, with U.S. payrolls for August and a gauge of Mexico's Consumer Price Index.

We're going Yellow this week, looking at WTI setting more of a ceiling than a floor at $70 per barrel on Thursday. Expect the price of oil to drop lower if trade tensions heat up on both sides of the Pacific. Some sustained pressure may be present given the dwindling movement in Iranian barrels.

Risk level: Orange - High

RED: Severe (+/- 4%) ORANGE: High (+/- 2%)  YELLOW: Elevated (+/- 1%)  BLUE: Guarded (+/- ½%)

THE BOOSTER SHOT

•             There's a fear factor that could be running underneath the market stream
•             The two "I" words – inflation and impeachment -- could have interesting links
•             If the price of oil inversely related to GDP, this week's rally is telling

The "I" word overshadowed some of the major international developments this week, and we don't mean Fed Chair Jerome Powell's statements on inflation at the Jackson Hole symposium. We mean, of course, impeachment. If the claims made by long-time "fixer" Michael Cohen are accurate, Trump at the very least has a poor memory when it comes to politicking. We've already traced a theoretical argument for waning confidence in U.S. leadership that suggests the president is at best secondary to systemic momentum. Now, however, we're forced to confront questions about U.S. confidence more directly. Recent consumer confidence measurements pointed to waning optimism and the latest poll AP-NORC poll found nearly three quarters of those surveyed said Trump's trade policies might cause prices for everyday goods to go up. That's inflation. While significantly weaker than it was in the 1970s, there is at least a loose relationship between inflation and the price of oil. Because it takes time for the price of oil, meanwhile, to catch up with the economy, we may not see it have an impact on U.S. momentum just yet. But it could be a sign of things to come. For the week, it was a large draw on U.S. crude oil inventories, a dovish stance by Powell and some signs of a drop in the global trade war temperatures driving the price of oil. The movement in the price of Brent crude oil for the week was above what our scale accounts for, ending up 5.29 percent to close the week at $75.63 per barrel.

"I tell you what, if I ever got impeached, I think the market would crash," the president said this week. "I think everybody would be very poor, because without this thinking [points to his head], you would see numbers that you wouldn’t believe in reverse."

A 2004 report from Jennifer Jerit at Southern Illinois University highlighted how political rhetoric and emotions are linked. Political leaders, she argued, have an incentive to use language that evokes strong emotions in the voting public. Emotions, meanwhile, trigger our first political response, leaving logic as a secondary stimulant. Jerit noted that fearful people are risk-averse and unlikely to want to change course. It's angry people that want change. Trump with his claim of economic collapse is using fear to keep calls for his impeachment at bay. On the campaign trail, he used anger to drum up support.

Fear is linked to anxiety over an uncertain future, which leaves people favoring the known over the unknown. Fear is the feeling people have when they lack confidence about their security in an uncertain future. The latest gauge of consumer confidence from the University of Michigan found sentiment dropped to its lowest level since September 2017. Consumers when asked by surveyors said they were concerned about the rising prices for household goods, vehicles and homes. According to Surveys of Consumers chief economist Richard Curtin, "consumers have become much more sensitive to even relatively low inflation rates than in past decades."

Speaking on Friday from Jackson Hole, Fed Chair Powell noted that inflation has moved above the comfort-zone 2 percent rate, but "we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating."

Most Americans disagree, however. An Associated Press-NORC Center for Public Affairs Research survey published Friday found about 60 percent of those responding to pollsters questions said they disagreed with how Trump was dealing with international trade. Even worse, 72 percent said U.S. trade policy was causing the price of goods to go up. And in a testament to the perplexity of polling data, 51 percent also said Trump was doing a good job on the economy.

So what about the other "I" word. If there ever was a testament to a decline in confidence in the American system, impeachment is it. It's a quasi-political, quasi-legal action against the head of state. Comparisons between Collusion-gate and Watergate are commonplace in the recent news cycle. Against the backdrop of the Watergate investigation, the Nixon administration was navigating through a period of a dramatic spike in inflation, a stock market in free-fall and the Arab oil embargo. In the Trump era, the current bull market is on pace to become the longest one ever. But we're also reminded of Stein's law -- "If something cannot go on forever, it will stop."

On the more fundamental issues of supply, we are starting to see buyers move away from Iranian oil, indicating the slow drain of the millions of barrels of oil flowing from OPEC's third-largest producer has begun. With little spare capacity left in the market, we wonder if this week's rally in crude oil prices is a sign of things to come in November. There are loose indications to suggest that higher oil prices are correlated with a slowdown in growth in gross domestic product in the next year. Those watching the yield curve already know there are signs of a slowdown coming. OPEC economists said in their latest report the growth in U.S. GDP should hit 2.9 percent this year, but then slow to 2.5 percent in 2019.

With more of the people in Trump's inner circle getting immunity from prosecutors, we're expecting the cycle of fear to continue. If that spills over to a weaker dollar as confidence in the U.S. system wanes, this week's rally could continue. In upstream, Baker Hughes offered few headwinds with a decline in rig counts. Could that be an indication of rising costs of steel somehow?

It may be light trading week ahead because of the long U.S. holiday weekend, but there's no time to relax. On Tuesday, we get another look at U.S. consumer confidence, something to pay attention in the wake of the AP-NORC poll. The latest U.S. GDP numbers come out on Wednesday as do data on pending home sales.  Thursday brings a gauge of Canadian GDP and July consumer prices in the United States. The week ends with Chinese manufacturing PMI and the eurozone consumer price index.

We're going Orange for next week, expecting a run higher for crude oil. The British labor strike continues in the North Sea and we've seen two straight weeks of shockers from the EIA. The price could moderate, however, on easing trade tensions as Chinese officials said Friday that recent trade tracks were constructive.