The oil market is paralyzed. The two major crude oil futures contracts moved in a range of just over $2/bbl last week. WTI registered a weekly gain of 4 cents/bbl and Brent closed 10 cents/bbl lower on the week. Financial investors appear to have gone on holiday. Net speculative length in WTI was unchanged last week although in Brent money managers added 10 million barrels to their exposure. US drillers cut the number of rigs only by one. Volatility has fallen from 50% at the beginning of the months to 30%. Not even the JMMC meeting was able to breath some life into the market. The extra 2 mbpd of oil from the OPEC+ group seemingly lived up to expectations. This stalemate, however, is not the product of a balanced market. There are a number of uncertainties that keep market players cautious and on the sideline. These factors can have a profound impact on the supply-demand oil balance. The most important of them are the potential second wave of the coronavirus outbreak, which could disturb the underlying demand recovery and the dilemma how long resilient stock markets are able to provide price support for oil.
On Saturday, the WHO reported a record daily increase in new coronavirus cases for the second consecutive day. Total cases are now over 14 million worldwide. The US, which accounts for just 5% of the global population is responsible for more than 25% of the cases. It is followed Brazil, India, and Russia on the list of the most infected countries.
Equities live in the world of their own
Despite the relentless spread of the virus stock markets are unbelievably optimistic. In fact, they have decoupled from reality. The MSCI Global Equity Index is less than 6% off the pre-pandemic high reached in February. The S&P 500 Index has done even better. It has rallied 47% from the low in March and on Friday it closed a mere 4.8% below the February peak. The impressive performance is mainly based on the unprecedented fiscal and monetary stimulus measures launched by governments and central banks all over the world, nevertheless, the current state of the global and regional economies simply does not justify the underlying enthusiasm. Of course, markets can remain irrational longer than one can stay solvent, but a correction can come any time now and this would have a negative impact on oil demand growth.
There are several worrying aspects that show that the current bull market in equities is not sustainable. The finance ministers of the G20 countries pledged on Saturday to use “all available policy tools” to support the global economy but warned of uncertain outlook. They called on creditors to fully implement a short-term debt freeze for the world’s poorest countries but did not recommend extending the initiative into next year, let alone answering calls for cancelling debts for those hit hardest by the pandemic. Poorest countries will be unable to reduce their debt levels without help from creditors and this will ultimately have a negative impact on global growth.
The US economy is seemingly on solid footing – just look at the stock market performance. US banks’ quarterly earnings are encouraging and the Fed’s support in the form of bond buying is bearing fruit. Companies suffering from the pandemic are provided with a lifeline and the US central bank has even started purchasing junk bonds. Aggregate supply, let it be agricultural, manufacturing or service, is ensured for the time being. The problem is the demand side. In the week ending July 11 initial US jobless claims stood at 1.3 million, down 10,000 from the previous week’s revised level. Although it marked the 15th consecutive weekly decline total filing over the past 17 weeks jumped over 51 million. The unemployment rate in June dropped to 11.1% but it is well above the February level of 3.5%. With several states re-imposing lockdowns and the Paycheck Protection Programme unlikely to be extended beyond August no significant improvement in the job market is anticipated in the near future. Consequently, aggregate demand will suffer, and this will be a drag on the US economy and on equity prices.
In Europe political leaders spent the weekend to try and thrash out the details of the €750 billion post-Covid recovery plan. The marathon attempt to split the cash amongst EU member laid bare the divisions within the European Union. The deal is in the vital interest of Germany, the biggest exporter in the union. Without it, it would lose crucial markets and aggregate demand would suffer. The frugal four -Austria, Sweden, Denmark, and the Netherlands- want significant cuts to the package and are also against handing out grants as opposed to loans. Southern European countries, including Spain and Italy, strongly object any cuts. And there are those who are takers but not givers. Hungary, Poland, and Slovenia threatened to veto any compromise that makes the respect of the rule of law a pre-condition of the distribution of the aid. Some progress has been reported overnight but without the deal the post-coronavirus economic recovery will considerably slow down.
The Chinese economy expanded 3.2% in the second quarter after a contraction of 6.8% in the first three months of the year. The official figure beat expectations as there are green shoots all around. The dollar-denominated exports and imports increased in June and the manufacturing sector also grew. Headwinds in China, however, are also created by sluggish consumption. June retail sales fell 1.8% from a year ago. The economic recovery is uneven and there are growing concerns whether domestic demand can absorb inventories that keep rising due to weak external demand. Maybe, China signalled last week what to expect in the global stock market. The Shanghai Composite Index has lost 7% since July 9 (although it corrected upwards this morning). A sell-off in global equities would send shivers down the spines of those who believe the recovery in oil demand will continue unabated. It looks increasingly likely that global aggregate demand will only grow substantially if a vaccine is developed to successfully fight the pandemic. And it is not expected this year.