Keith Underwood 13 Comments

OPEC – Organization of Poor Examples of Coordination

Ho hum. The latest agreement out of OPEC is a proposed reduction of 800,000 barrels per day. Handily, the actual specific details of the reduction has yet to be finalized and that leaves who, what, where, when, and how to be sorted in November. Let’s see what can be agreed in a warring region of the world where trust is at a low and adherence to production limits are historically slippery for some.

 

800,000 may be an overly optimistic cut given that Iran has only just agreed to join the discussion. They have refused, on several previous attempts; to even show up to talks. Other oily actors like Russia seem intent to play ball by their own rules, so don’t plan for anything that doesn’t benefit them. As a non-Opec member they are likely to not participate in a reduction. Even if they did would you believe them?

 

Should Opec succeed in their production cut theatrics and sustain a higher price of $55-$60 per barrel, the higher oil price will encourage shale producers to dust off the projects that were uneconomical while oil was below $40-$45 per barrel. The higher the price goes the more potential supply realized by projects left idle before.

 

So what’s this have to do with the foreign exchange market you ask? Well, while all this hoopla is going on we will see increased headline trading (quick, sharp, short movements) in spot FX with currencies that are correlated to the price of oil. Correlation is the generalized movement of one asset versus another (either positive or negative). So if oil increases in value you might see an increase or strengthening of the Canadian dollar (oil exporter) versus a country that is a consumer (importer) of oil such as the European Union or Japan. Other exporters that could also benefit are Russia, China, Brazil and Mexico.

 

Oil has been trading sideways all year long (see chart) and anytime you have a prolonged period of consolidation or range trading, the breakout move (out and away from the previous range) will be that much greater and volatile. Think of a Jack-in-the-box toy that is wound and wound and wound until it pops. This is typically what happens the longer that a tradable asset stays within a predefined or preexisting range. Oil could be in this type of situation, but so too are many other tradable assets, due to concerted government intervention in the interest rate markets keeping rates low or even negative, for longer. See ‘Negative Interest Rates: A Disincentive to Risk’ for my pessimistic views on negative rates.

Trading range oil 2016

As such, the inflection points or ranges that has developed over months and years will ultimately break and bring with it severe liquidity shortages and violent gapping movements. Could OPEC produce a breakout moment with a viable and substantial agreement to cut production? My opinion is that they could, but we have been down this path many, many times before and I can’t really get that excited about a re-run where there is no real emergency for the cartel members to act. Expect a bland communiqué that expresses dismay at the present low price of oil, the need to keep the global economy growing (to use more oil) and production cuts that will be in the best interest of the cartel.

 

keith@underwoodfx.com 

Traded Markets Intelligence

UnderwoodFX.com

Keith Underwood 2 Comments

4 Things That Worry Me

  1. The Japanese yen (110.50 today) is strengthening versus the US dollar (52 week range 110.27 – 125.86) and the yen is typically viewed as a safe haven currency during market uncertainty and turmoil.
  2. The 10-year US treasury yield (1.74%) is lower (30% from it’s June 30th 2015 peak of 2.50%) even as inflation expectations are picking up. Safety is being sought as yields drop.
  3. Gold (1220.50) is, and has been rising, since December and now stands nearly 21% higher. Gold is also a safe haven for investors.
  4. Central bankers are using negative interest rates as a policy tool. Disaster.

 

Am I missing something here? Why are these 4 (should we add in oil as a fifth?) indicators painting such a negative picture and the world is just shrugging with acceptance? These 4 macro measures of the health of the investment community are not good. They are each, on their own, somewhat interesting, but together, these smell like the tin of tuna in the back of the fridge that was forgotten about months ago.

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Keith Underwood 2 Comments

The Fed’s Dual Mandate

Every person that has taken a macro-economic course is aware of the Fed’s dual mandate, but for those that haven’t, a bit of history to get this blog post going. In 1977, Congress amended The Federal Reserve Act, stating the monetary policy objectives of the Federal Reserve as:

     “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

The dual mandate being consolidated down to maximum employment and stable prices, which equates to approximately 5.35% unemployment rate and 2% inflation. With the economy creating about 260,000 jobs a month and the unemployment rate at 5.5%, the Fed is accomplishing the employment mandate. Unfortunately, the inflation rate is running well below the 2% target rate and, by it’s own admission, the Fed really doesn’t think it will reach that level until 2016, as stated by is most recent economic assessment from December 2014. Their data is below:

We are in the midst of the most dramatic deflationary pressures on the US economy since the 2008 crisis. May I remind you of the effects of dramatically lower oil, a strong US dollar, and tighter money supply had on US CPI?

I am not suggesting that we have negative CPI in our midst, but I can’t ignore the potential for downward pressure on inflation with these powerful forces, once again acting in unison. In 2008 when oil (WTI) fell 69% and the dollar trade weighted index (TWI) soared 20%, CPI dropped from 5.5% to -2%! In the last year, oil is 58% lower and the dollar TWI is 11.4% higher. A back of the envelope estimation is that CPI could drop 3% or 4%? If the Fed acts according to it’s dual mandate, I can’t see how it moves rates higher, while CPI has the historical prospect of falling significantly in the coming months. Yikes!

Next weeks Fed meeting should prove interesting because the world will be watching to see if they remove the word ‘patient’ from their statement, which would signal that they are open to raising (normalizing) rates. While this development, if it occurs, will be seen as opening up the potential to raise rates, it will be difficult for voting members to square with the Fed’s dual mandate and raise rates while inflation is poised to head lower.

 

www.acurrencyaffair.com

 

Quick, discreet, and so worth the risk.

 

Keith@UnderwoodFX.com

 

 

 

Keith Underwood 1 Comment

The FED will not raise US interest rates in 2015

A perfect macro-economic storm has erupted that the FED did not anticipate. As a result of the storm, the FED will delay raising interest rates from mid-2015 until early 2016. The FED did not foresee that global macro-economic events that have recently unfolded would collide in spectacular fashion and force their hand to stay put. The powerful combination of a vastly stronger US dollar, the collapse in the price of oil, and struggling world growth will keep the FED from raising interest rates in 2015.

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US December Nonfarm Payrolls

The headline number is that total nonfarm payroll employment rose by 252,000 in December and the unemployment rate declined to 5.6%. Job gains occurred in professional and business services, construction, food services and drinking places (I’m not making this up), health care and manufacturing. Added to this are revisions from the previous months where October was revised from +243,000 to +261,000 and the change for November was revised from +321,000 to +353,000. With these revisions, employment gains in October and November were 50,000 higher than previously reported. All in all, the year ended on a very strong footing for job creation and the best since, wait for it, 1999.

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