Something very strange happened on Friday. The US President had told reporters that he never agreed to roll back tariffs on China and the market ignored his comment and recovered impressively from the short-lived dip his remark caused. Friday’s price reaction might just imply that there is a growing confidence on a gradual truce between the two duelling nations. This optimism started to get widespread when the so-called Phase 1 trade deal between the US and China became plausible last week. There are still a few things to agree on, amongst others to grant China’s wish to mutually cancel tariffs in stages as a pre-condition to sign the deal (reportedly there is significant opposition within the US administration for the roll back) but the outlook is probably brighter than ever. It is true even though prices are retreating this morning due to the lack of fresh trade developments.
The potential for such an agreement has greatly increased risk appetite. Whatever happens and two biggest economies in the world becoming best friends is anything but a foregone conclusion, investors have lately been willing to take money out of safe havens and channel it over into risky assets. Last week’s price movements were yet another example of what has been common knowledge over the past year or so: that is that the US trade policy is the biggest concern for investors and it is the main price driver very much across the financial and commodity spectrum. It is, therefore, no surprise that gold lost more than 3.5% last week and fell to $1,458/ounce whilst equities had a good 5-day period. The S&P 500 index made new historic highs almost on a daily basis and the Dow Jones Industrial Average Index jumped 1.22%. The Chinese currency has, for the first time since the beginning of August, strengthened below the Yuan 7 mark against the dollar.
To put it simply investors voted with their dollars and once again made it clear what they think – trade wars are bad, trade deals are good. They do not like uncertainty and the potential removal of a certain amount of it has been rewarded by strengthening stock markets. Uncertainty is seemingly being removed from the UK, too but scratching the surface reveals that the Brexit process is far, far away from being resolved. The snap election on December 12 is a welcome step as a currently paralyzed Parliament could become functional again; however, there will be no good outcome, only bad, worse or worst.
If no party wins majority the uncertainty will prevail as the parliament will remain practically dysfunctional. There is a chance of that because the Brexit party will nick votes from the Tories and the Liberal Democrats from the Labour not the mention the intentions of the Scottish National Party. In case Labour wins majority… well, just read any English newspaper about their economic agenda that is sending shivers down investors’ spines. In case the Tories win, as currently expected, they claim that they will “get Brexit done” in January. This is a brutally effective campaign slogan but the fact of the matter is that under this scenario the Brexit process will just begin. Let us recall that only three things have been agreed with the EU (which still has to be approved by the parliament): the amount of money the UK will pay to the EU, citizens’ right and the Irish question. Trade negotiations will start early next year and the UK and the EU will have until the end of the transition period to come up with a deal. That is less than 12 months when these trade talks usually take years. The message is that one must not exclude the possibility of a very hard and nasty divorce that could ultimately end without a trade deal. The sterling failed to maintain the momentum from two weeks ago when it broke above 1.3 against the dollar and lost 1.3% last week.
Oil usually follows equities as trade tension ebbs and flows but the picture from last week is not as clear cut as it seems. The latest period saw crude oil take a different path from products. The two major crude markers, WTI and Brent have both posted gains over the week but RBOB, Heating Oil and Gasoil have registered losses. The flat price strength in crude oil is understandable – money managers supported the outright levels as equities advanced. The intriguing development is that the structures have strengthened, too. US crude oil inventories built significantly last week, partly because Cushing stocks increased, too. Yet, the front-month WTI spread got 5 cents/bbl stronger and the January/February spread displays a semi-decent backwardation (+16 cents/bbl). This is possibly down to the Keystone pipeline problems. After a leak was discovered in North Dakota the pipeline was shut. This supported local grades against Canadian ones. The West Canadian Select has weakened nearly $6/ bbl against WTI in the last two weeks. No wonder that shipping crude from Alberta to the US Midwest by rail has now become economical. Latest reports say the pipeline could come back online within weeks but partial restart is expected this week. This is when the WTI structure should weaken again unless favourable Trans-Atlantic economics allow US crude oil exports rise well above the 3 mbpd level again.
In Europe the front-month Brent spread is amazingly resilient. It has jumped 18 cents/bbl last week and is now at 90 cents/bbl. The physical crude market, especially for Russian crude also looks tight. The Russian seaborne export crude now commands a premium over Brent both in NWE and in the Mediterranean. Maybe refiners have started to accommodate crude oil which is suitable to produce lower sulphur fuel oil ahead of the launch of the new IMO 2020 standard from January 1. This can explain the lacklustre performance of Heating Oil and Gasoil but demand for this product might increase drastically once the new regulations become effective in less than two months’ time.