Market Recap

Posted on September 20, 2019 by Gemmer Asset

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Week in Review


The focus this week, at least as far as the markets are concerned, was meant to be one thing and one thing only – the Fed meeting on Tuesday and Wednesday. But when the futures opened Sunday evening it was all about oil. Oil prices soared following a drone attack on the Abqaiq oil-processing plant and the Khurais oilfield in Saudi Arabia on Saturday. At one-point oil surged as much as 20% – the biggest intraday jump since Iraq invaded Kuwait almost 30 years ago.


Initial estimates were that about 5.7 million barrels a day of supply was taken offline, roughly 5% of the global supply. This is a big deal – it would be the biggest supply disruption since the late 60’s, as you can see below.



But the markets were pretty unfazed by the attack. Part of the reason is that the price surge didn’t even get oil prices back to the spring highs, as you can see below.



Also, supply disruptions, at least from a U.S. perspective, aren’t what they used to be. As you can see below, we simply don’t import much energy anymore.



If anything, higher prices will boost capex investment in the U.S. as energy companies boost drilling.


Finally, the supply shock is going to be short lived as the Saudi’s are going to restore supplies relatively quickly. Oil prices for the week ended up +5.8% but are still down about -12% from the spring high.


October Rate Cut is Far From a Done Deal


Now to the Fed. As expected, they cut rates by a quarter-point or 25bps on Wednesday and maintained their pledge to “act as appropriate to sustain the expansion.” However, the decision wasn’t unanimous. Two board members voted to leave rates unchanged while a third argued for a bigger half-point cut.


All in all, pretty much as expected. Chairman Powell emphasized in the press conference that this cut was an insurance cut against slower growth going into the end of the year. At the moment the market is torn on whether we’d see another cut before December. Currently the market is putting a 1 in 3 chance of no change in rates through December and a 50% chance of one more cut.



It certainly looks like we will need to see softer data in the next six weeks to get the Fed to cut again. As Tim Duy notes:


“Another scenario is that the data improve in the months ahead. This week’s data flow fits with such a scenario. Despite concerns about the manufacturing sector, industrial production rose 0.6% in August. And overall weakness in manufacturing falls well short of the more substantial yet still non-recessionary declines in 2015-206. Housing starts, traditionally a very good leading indicator, have fully recovered from last year’s malaise with a jump in August that brought starts to a cycle high.


Data of this nature, if sustained, would rightfully lead the Fed to believe that is has short-circuited any incipient recessionary dynamics with their midcycle policy correction. That outcome would in turn not just lead the Fed to abandon an October rate cut but also a December cut as well. In other words, if the data start improving, the 2018-2019 recession scare will end just like in 2015-206 – without a recession.”


The Return of QE


Even if the Fed doesn’t cut rates again this year, they are likely to start growing their balance sheet again. This is due to the disturbance in the force that governs some short-term borrowing costs.


This week the so-called repo rate surged to unprecedented heights, as you can see below.



A repo, or repurchase agreement, is simply a deal where I buy a bond off of you to give you some walking around cash, but you promise to buy the bond back tomorrow, or the day after. You are willing to pay a rate of interest for the convenience of getting some cash. This rate typically tracks short-term rates like the Fed Funds rate. However, this week the demand for cash was so high that some were willing to pay upwards of double-digits for liquidity.


There’s a whole host of reasons why this could be happening – corporate tax payments are due, rising budget deficits and increased Treasury issuance, quantitative tightening, etc, etc.


But regardless, the Fed was forced to step into the markets four times this week and offer basically a borrowing facility for those who needed cash. This fixed the problem as repo rates fell to 1.95% on Friday. But more will probably be needed. Bank excess reserves have been in a downtrend for a while now. This is contributing to the problems in the repo market.



To fix this the Fed may go down the path of more quantitative easing. As BCA notes:


“The Fed is also likely to start expanding the size of its balance sheet starting in November. The spike in funding rates this week, while not at all related to the sort of counterparty risk that prevailed during the financial crisis, still underscored the fact that bank reserves are becoming increasingly scarce. To the extent that the Fed creates bank reserves when it purchases assets, this would help alleviate funding pressures.”


So even though we might not see another rate cut, policy is going to get modestly easier over the next few months. This is true globally as well. Just this week we saw the following policy changes:


  • Brazil cut rates by 50bps


  • Saudi Arabia cut rates by 25bps


  • Indonesia cut for the third straight month by 25bps


  • Hong Kong cut by 25bps


  • The Bank of England didn’t cut, but they struck a dovish tone, raising the prospect for the first time that it might seek to cut rates if Brexit uncertainties persist.


  • The Bank of Japan also didn’t cut but hinted at potential action in October.


  • India didn’t cut rates either, but they did cut corporate income taxes from 30% to 22% for existing companies and from 25% to 15% for new companies.


What if Japan Runs Out of Beer?


Every four years the Rugby World Cup is held. Back in 2015 New Zealand held the trophy aloft (again), much to the chagrin of pretty much the rest of the world. There have been eight world cups since the first one back in 1987, and New Zealand has won three of them (1987, 2011, and 2015), placed second once, and third twice.


They are of course favorites to win again this year, but the field is awfully competitive and they are far from a shoe in. However, there is a far more important question. Will the host nation have enough beer to hydrate all the spectators?? To quote a Bloomberg piece:


“Watching rugby and drinking beer go hand in hand. While the Japanese like beer—they drank 53.5 liters per person in 2018—the British, Australians, and Irish, some of the sport’s biggest aficionados, typically consume about double that amount, according to Euromonitor. About a third of ticket sales have gone to overseas fans, mostly from those three countries.


Foreigners are expected to drink about four times as much as Japanese spectators, according to the organizing committee. That has brewers, distributors, and bars in Japan taking steps to avert a shortage, as the six-week competition gets under way on Sept. 20 for the first time in Asia.”


Running out of beer wouldn’t be unprecedented.


“At a Japan versus Australia rugby match in 2017, held near Tokyo, the stadium ran out of beer halfway through the game. And at the 2015 cup, hosted by England, 1.9 million liters of beer—enough to fill four-fifths of an Olympic-sized swimming pool—was consumed in stadiums and official viewing parties.”


That’s a lot of beer!!


And while you worry about the beer situation in Japan, spare a thought for England’s team when they line up against Tonga on Sunday. They will be facing what has to be one of the biggest props in history – Ben Tameifuna. Official numbers peg him at roughly 136kg or about 300lbs, but he’s probably closer to 150kg. Could you imagine standing your ground in front of him as he rumbles down the field?



It was great to see Japan win their opening game against Russia in convincing fashion.


Unfortunately, the odds of a successful U.S. World Cup are running at about 2000:1. Ouch!!


Have a good weekend.






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