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OPEC under pressure, China worries about off-balance sheet debt

OPEC faces a potential end-game as Iranian oil returns and Net Zero policies start to reduce fossil fuel demand. Central banks in the USA and China face the need to start deflating the bubbles they have created.


Oil

The likely return of Iranian oil pushed Brent down $2.20/bbl to $66.73/bbl, as prices hit the resistance level in place since 2013.

✦  HIGHLIGHTS

  • Last week’s Net Zero by 2050 report by the International Energy Association (IEA) is likely to prove massively influential
  • The IEA has guided OECD energy policy since it was formed after the 1974 Arab Oil embargo
  • It is now calling for an immediate end to all new oil and gas projects
  • The G7 has already agreed to phase out financing for fossil fuels and remove fuel subsidies 
  • It also seems likely that Iranian oil will make an early return, as the nuclear negotiations enter their final stages
  • OPEC now faces very painful choices:
    Make further output cuts to support prices as Iranian oil returns
    Or decide they have to “pump it or lose it” In response to the IEA report

WATCH FOR

Potentially fatal tensions at the OPEC meeting in June


S&P 500

The S&P ended another rollercoaster week down 0.4% at 4156. The VIX fear gauge was volatile but ended up only 1 at 20

✦  HIGHLIGHTS

  • Equities sold off early in the week on concerns of potentially persistent inflation
  • Markets were then supported by positive economic data and promises of continued Fed support
  • But it seems likely the market’s belief in the “Fed-Put” will be tested over the summer
  • Atlanta Fed President Bostic warned of “a lot of volatility over the next several months.
  • Citi’s U.S. economic surprise index turned negative on Thursday for the first time since March 2020

WATCH FOR

Market nervousness to continue as recovery assumptions continue to be questioned


Interest rates

The 10-year rate ended the week slightly lower at 1.63% (from 1.64%), having revisited 1.69% on Wednesday on inflation concerns. The MOVE volatility index closed unchanged at 55.

✦  HIGHLIGHTS

  • Wednesday’s Fed minutes (from 28 April meeting) indicated no imminent change to its monetary posture, BUT
  • A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”
  • Rates for sovereign Euro debt continue to rise, increasing speculation that the ECB will slow its QE purchases (decision due on 10 June)
  • Away from sovereigns, the WSJ estimates that “More than $5bn of bonds and loans designed to fund green initiatives are now issued every day.
  • Cryptocurrencies are again feeling the pressure as China looks to increase controls and Biden seeks to reduce tax-evasion

WATCH FOR

Fed to remain under pressure on inflation


China

The government continues to target unregulated shadow bank financing. This is causing increased pain in the private sector, as the official banks normally prioritise lending to other state-owned borrowers.

✦  HIGHLIGHTS

  • The growing liquidity crunch is impacting many sectors, from chemicals to real estate.
  • Funding sources are being reduced, when growth capital is needed to support cash-flow as the economy recovers
  • The state-owned banks are strongly biased towards lending to other state-owned entities.
  • Most notably the property sector (29% of GDP) is showing cracks, with bond defaults rising
  • Private companies are also now finding it diffiuclt to agree new loans to service existing debt
  • Major restructuring of many private sector companies is imminent.

WATCH FOR

Distressed sales to start as companies forced to sell off assets to reduce shadow debt


Summary

Real world issues of supply/demand and affordability are starting to challenge OPEC – and the myth that central banks can always keep markets moving higher.

Oil

S&P 500

Interest rates

Market view today

Some concerns

All news is good news

Expecting modest inflation

Our current view

Negative

Reversion to mean inevitable

Expect long-term deflation

Positioning began

March 2021

March 2021

December 2020

Confidence level
Initial
Today

.

.

.

Relevant positioning

Reality starting to dawn

Waiting for reality to dawn

Expecting higher rates for the 10-year and longer-dated Treasuries

Confidence level: = 100%,  = 75%, = 50%, = 25%


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This Research Note has been prepared by New Normal Consulting GmbH for general circulation. The information contained in this Research Note may be retained. It has not been prepared for the benefit of any particular company or client and may not be relied upon by any company or client or other third party. New Normal Consulting GmbH do not give investment advice and are not regulated under the UK Financial Services Act. If, notwithstanding the foregoing, this Research Note is relied upon by any person, New Normal Consulting GmbH does not accept, and disclaims, all liability for loss and damage suffered as a result. The pH Report and pH Outlook are published by New Normal Consulting GmbH.
© New Normal Consulting GmbH 2021