Could this be the biggest monetary policy meeting in years?

Forex

Could the upcoming Federal Open Market Committee (FOMC) be the most watched monetary policy meeting in a long time?

It certainly has a lot weighing on it.

Stocks are at record highs, pushed higher by a certainty that the FOMC will cut short-term interest rates for the first time in a decade this week. The two-day policy meeting kicks off on Tuesday, with a policy decision announced on Wednesday.

While Chairman Jerome Powell signalled a cut in July, its unclear what the policy could be for the rest of the year. And is a cut even necessary? While the consensus is that a cut is coming – the only quibble is 25bps or 50bps – the recent economic data looks strong. As our Chief Markets Analyst, Neil Wilson, explains:

“Is a cut justified? I would point to underlying core CPI at 2.1%, retail sales +3.4% in June and a 50-year low in unemployment as perhaps arguments to the contrary. Increasingly there is a sense that the Fed is no longer data dependent, but being held to ransom by the White House and the market.”

But what can we expect from the meeting?

The answer is, it depends…

Confirmation of a cut from the FOMC, if paired with signals of a more dovish policy in the long term could send greenback diving.

On the flip side, if the markets are surprised and a cut doesn’t happen, expect stocks and commodities to tumble and the dollar to surge.

At this stage, despite stronger-than-expected data, growth momentum is weaker. While a recession has been avoided, a cut is still the safe bet. This policy meeting could define the direction of global monetary policy for years to come and provides a lot of opportunities for traders. One thing’s for sure, the announcement on Wednesday is not one to miss.

Commodities: Gold hits five-year high as Fed strikes dovish tone, crude oil up after attack on US drone

Gold is trading at its highest level in more than five years after the US Federal Open Market Committee yesterday indicated that monetary policy may become more accommodative.

Gold has gained 1.7% after the FOMC held rates in the 2.25-2.5% range but signalled a cut was coming. It’s trading around $1,383 after rising to test resistance at $1,394 – prices haven’t been this high since March 2014.

Bulls may now be targeting the $1,400 handle, but there is plenty of room for a pullback before support comes into play at $1,362.

Fed Chair Jerome Powell stated in the post-meeting press conference that “Many participants now see the case for somewhat more accommodative policy has strengthened.”

Markets had been pricing in a rate cut in July. A weakening US dollar has helped push commodity prices higher in the wake of the meeting. Cable is up 0.6%, EUR/USD up 0.5%, and USD/JPY down 0.4%.

Crude oil rises as US and Iran clash over missile attack on drone

Oil prices have extended gains of up to 3% today after tensions in the Middle East cranked higher. Washington claims that a US military drone was shot down by an Iranian surface-to-air missile in international airspace. Iran’s Islamic Revolutionary Guard asserted this morning that the drone had entered Iranian airspace.

Tensions between Washington and Tehran have been building of late, after the US accused Iran of carrying out the recent attacks against oil tankers in the Gulf of Oman. Iran’s oil exports are the subject of sanctions by the US which came into force last year.

The news pushed Brent up to a ten-day high of $63.85, while crude oil rose to a 20-day high above $55.50.

Oil rallies on Oman tanker fire

Morning Note

Oil rallied on geopolitical tensions in the Middle East while equities started to look like they are range-bound ahead of the FOMC meeting.

Oil jumps

Oil has shot up sharply after slumping to 5-month lows overnight. Reports of an oil tanker being on fire in the Sea of Oman rattled markets and sent Brent up $2 in a matter of minute, but await to see whether this will hold or is an algo-based kneejerk that will be faded. We know that geopolitical tensions in the region are worsening and raise supply-side concerns in terms of short-term outages etc – but with OPEC already curbing output and US production at a record high the market is far less susceptible to a shock.

A surprise build in US inventories was to blame for the drop yesterday and ultimately be more important than what’s happened in Oman. EIA figures showed stockpiles climbed by 2.2m barrels, against an expected decline of around 500k. At this time of year we’d normally see stocks decline but they keep moving higher. More supply, not enough demand. This is squeezing longs and we should see further liquidation in speculators’ net long positions, twisting the screw more.

With the demand outlook so clouded there is no sense that the bear market will end any time soon. Massive US supply has changed the rules of the game and there’s not a lot OPEC can do about it. Brent recovered to the $60.50 area having dropped below $60, before it spiked on the Oman news to trade through $62. Risks skewed to downside – it looks like $50 will be seen before $70. However, we’re in a major support zone and the latest dip could be the second trough in a double-bottom reversal.

Equites retreat

Equities pulled back again yesterday – nothing new in terms of trade, just a loss of stamina it seems. SPX encountered important technical resistance and retreated to 2880 on the close. Markets in Europe retreated as the rally ran out of legs.

European shares were on the back foot again on Thursday but then turned green. Bulls may retake control but until the FOMC meeting Wednesday we may expect the major indices to trade in these ranges. Hong Kong again weaker again amid the protests.

US president Donald Trump says China will make a deal. Well we’ve heard all this before. The markets starting to ignore this rubbish. There is precious little signs that we are even close to seeing a deal done at the G-20. Maybe a top-level handshake between Trump and Xi but hard to see much more.

Trump also said he’s still looking at placing sanctions on the planned Nord Stream 2 pipeline. It’s been talked about before but it raises spectre of increased tensions between Germany and US (see euro below softer). The project is controversial enough within the EU and creates the potential for further fracturing among EU states. On this Trump has many European allies. And as the Mexico farrago showed, Trump is not afraid to weaponize trade/tariffs for the pursuit of non-economic policies. We know he wants EU members to stump up for defence.  It’s not a giant leap to see Trump weaponizing trade to achieve this ambition. One can anticipate deterioration in relations.

Tory race

In the UK political space, the Tory leadership first vote takes place today. It’ll sort some the wheat from the chaff but still doesn’t get us to the final two. But there will be implications for who’s going to pick up the votes later on from the candidates that don’t make the first pass.

Sterling had rallied a touch on Boris’s speech – algos in overdrive most likely – before slipping back below $1.27 again as Parliament refused to back Labour’s motion to take over business and take no-deal off the table.

Euro breakout fades

In FX, the euro inched up a touch Thursday after a fairly significant sell off yesterday that will have stressed bulls. The drop in the euro seems to be down to the Trump talk on Nord Stream 2 and the prospect of a worsening in relations with Germany. Last look EURUSD was trying to regain the 1.13 handle. This breakout looks like Monty’s sluggish, meat grinder approach to Caen.

Meanwhile inflation expectations have been crushed – the markets calling out the ECB over stimulus hints and says you can do more but we’re not sure if it will work. Euro 5y5y inflation swaps sunk to record lows- below 1.2% for the first time. The ECB will be forced to do more.

Trump’s London calling, US-China trade war worsens, oil smoked

Forex
Morning Note

Global stocks were down by around 6% in May – can we get a better June? The runes are not looking great. 

Futures indicate European shares are lower today as trade tensions continue to mount and investors exhibit greater fear about the global economy and the risk of recession. Asian markets were generally lower after a big selloff on Wall Street on Friday that saw the S&P 500 decline 37 points, or 1.32%, to finish at 2,752.06, below its 200-day moving average. FTSE 100 held the 7150 level, but this is likely to get taken out today. 

Trade fears are heating up 

The trade war is not cooling down; in fact, it looks like the rhetoric is heating up and further escalation seems likely. China is raising tariffs on $60bn of US goods in retaliation for tariffs, coming up with its own blacklist of foreign companies, has accused the US of resorting to ‘intimidation and coercion’, and begun an investigation into FedEx. And the Chinese defence minister says if the US wants a fight, they will ‘fight to the end’. No end in sight, and the chances of a G20 détente are slim.

Futures 

US stock futures were lower along with oil amid growing fears about this trade setup. Nothing like progress has been seen re Mexico, and now the market is dealing with reports that the US has been eyeing slapping tariffs on some Australian imports, As we noted last week, the escalation last week with the attack on Mexico – especially as it represented a weaponization of trade to pursue non-economic policies – represents a major turning point and could bring others into the fray. Again, the EU could come under fire soon. 

PMI day 

Data overnight has been mixed but still indicates slowdown. China’s Caixin PMI read 50.2, unchanged from a month before but a little ahead of expectations. Japan’s PMI has gone negative, moving to 49.8, signalling contraction. Japanese manufacturing output down for 5 months in a row, while new export orders fell for the 6th straight month. Japanese equities were down sharply overnight. UK PMI at 09:30, with the ISM numbers for the US due at 15:00. 

London calling 

Trump heads to the UK today – unfortunately he’s meeting a lame duck PM so we can’t expect much of importance. There will be lots of talk of a trade deal with the US post-Brexit. Harder Brexiteers in the Tory leadership race are likely to be emboldened. Expect the no-deal talk to increase.  

Sterling is sure to be under plenty of pressure until the leadership race is clearer. GBPUSD remains anchored to 1.26 for now, having made fresh multi-month lows last week. However, Friday’s bullish hammer reversal may provide the basis for a short-term rally. Just a hint that the pound is oversold and could be ready for a wee bounce. 

Oil smoked, gold higher 

Oil has taken a beating as markets worry more about a slowdown in global demand than supply constraints. Brent has declined by 10% or so in just a couple of days and is holding on $61, while WTI is clinging to $53. Speculators are liquidating long positions wholesale, with Friday’s COT report showing net longs down by 40k contracts. Net long positioning has fallen by about a fifth (100k contracts or more) since the late April high at 547.4k. 

Stockpiles are at their highest in two years. Speculative long positions continue to be cut. Supply uncertainty is losing out to demand uncertainty. Simply put, with OPEC and co curbing output, there is ample excess capacity in the market should it be needed. 14-day RSI and 20-day CCI suggest oversold and ready for a bounce, but this is like trying to catch a falling knife. 

Gold meanwhile is picking up safe haven bid as this decline is not just about valuations but about big fears for the global economy. The easing off in the US dollar has also supported gold. Having broken $1300 gold was last around $1310, with next target $1324.

FTSE rebalancing etc

Finally, there’s a fair bit of chatter about the FTSE rebalancing – will Marks & Spencer survive in the 100? Will JD Sports be promoted? I wouldn’t get too worked up about it all, even if it’s good sport. EasyJet likely to go – shares have been hammered but the business is tightly run and it’s always been one of the smallest in the FTSE 100. MKS lucky to survive with only the rights issue saving it.

Kier – warning on profits – going from bad to worse after the rights issue flopped.  

Astra – hails Lynparza pancreatic cancer drug trials success 

William Hill – bid rumours are doing the rounds 

Dignity – says it welcomes Treasury/FCA proposals  

Morning Note: Market selloff, Uber tanks again, Vodafone grasps the nettle

Forex
Indices
IPO
Morning Note

It was another, more brutal sell-off on Wall St led Asian shares lower overnight, setting us up for a nervy session in Europe. Futures right now look positive but we may well see selling pressure re-emerge.

SPX closed 2.41% lower, taking it back to March levels. This was its worst decline since the turmoil at the start of January. The Nasdaq suffered its worst day since December as tech stocks were the worst hit from the fallout of the US-China spat. The Dow shipped over 600 points, to end around 25,324, with some of its biggest hitters affected by the China trade story directly (Boeing, Apple).

Risks for now seem very much skewed to the downside until we see some kind of equilibrium achieved again. The market is seeing the window for a deal causing tightly, although with tariffs not taking effect yet we could yet see some improvement in relations. If this is the third shoulder of a giant triple top in the market there is a hell of a long way to go lower. But we are probably not at that stage yet. The Fed remains on side – bets on a cut this year have shot up from around 50/50 to around 75%.

Commodities

Gold spiked higher as a risk-off proxy. Prices which had dithered around $1280 level for a while drive up through the big round number at $1300 and was last just down a shade beneath this.

Oil had risen amid escalating tensions in the Persian Gulf. However the reality of the trade war began to hit home later and crude prices slid again. Brent, which had leapt clear of $72, was last holding just shy of the all-important $70.60 level. This is a level we have talked about time and time again and it is proving something of magnet for Brent right – a decisive break in either direction could signal a fresh direction.

FX markets are completely ignoring the whole stooshie, although there a touch of movement in the Chinese yuan, but not a lot. Little movement for now as central bank liquidity is onside to keep volatility low. BoJ now also talking more stimulus should consumer prices lose momentum.

Uber stock reels post-IPO

It was a bruising session for Uber with shares down by more than 10% on the day. Adding insult to injury, they fell further after market to trade below $37.

Following the Uber and Lyft debacles, there are now questions over whether some remaining unicorns choose to lust this year. The likes of Airbnb and WeWork could decide to pull their planned IPOs until there is more certainty.

Moreover current market conditions do not seem favourable for listings right now and companies may prefer to wait for a rebound in the broad market before listing. That said, it’s too easy to lump all IPOs into the same basket and see a read across.

There have been notable positives in the latest round of IPOs – Beyond Meat, Zoom and Levi’s shares rising firmly from the strike price post-IPO. Perhaps it’s just a case of good old fashioned stock picking and valuations after all.

Vodafone cuts dividend

Vodafone has bowed to pressure and cut its dividend. Or rebased to use the euphemism. The dividend was cut from 15 eurocents to 9, which is a very hefty cut indeed and investors will punish this move. Unlike some notable others, though, Vodafone has grasped the nettle and chosen to put the future of the business ahead of short-term returns to yield hungry investors. Now it’s not great news, but at least it shows the new CEO is willing to think longer term and is seeking to manage the debt.

On top of controlling debt, one of Vodafone’s key problems is the very large investment needed for 5G rollout. Auctions in Italy and elsewhere (Sweden, Australia) indicate the enormous costs and further divestments to shore up the dividend whilst still investing enough in capex seems inevitable. It is very likely Vodafone will flog its towers as part of this strategy, or to use another euphemism in today’s update – monetise. Vodafone also announced that it will sell its NZ business for $2.2bn in a move that frees up some cash.

Today’s results were full of euphemisms actually. The raw results showed a 6.2% decline in revenues and a loss for the year of €7.6bn. But instead management is directing us to ‘alternative performance measures’, which show far healthier EBITDA growth of 3.1% and group services revenues rising by 0.3%. Caveat emptor. In addition to the 5G cost, Vodafone faces a number of competitive headwinds in Italy, Spain and South Africa. There’s a lot of restructuring going on amid big changes in the industry with 5G. Management seems to be grasping the nettle and should be allowed time to deliver on the strategy

US-Korea Talks End Without Deal, Oil Slips, IAG Results

Forex
Morning Note

US talks with North Korea have broken up without a deal. South Korean shares fell sharply as the meeting broke up, with Asian shares broadly in the red. I don’t think this will ultimately have too much bearing on global indices in the longer term, but for now with hopes of a deal with China on trade not exactly fading, but certainly not rising, it’s 0 from 2 for Trump this week and risk sentiment is suffering as a result. The combination of the lack of progress with North Korea and China will drag on equities and we might have to wait for a new catalyst to renew the bullish start to the year.

The FTSE 100 opened down 0.6%, extending its recent run of losses as it approached 7060. As we noted in yesterday’s note, the drop below 7100 brought this important 38% retracement level into focus. Below lies the 7000 round number target for bears, which is roughly where the channel trend support kicks in. 

Oil was on the defensive as US production hit a fresh record and weaker Asian PMIs pointed to slackening demand.  

China’s manufacturing PMI fell for a third straight month in February, slumping to a three-year low. Meanwhile Japan’s industrial production notched up its biggest fall in a year, slipping 3.7% in January. A definite sense that this is a symptom of the ongoing trade tensions and with no resolution in sight, data should continue to slacken and this will likely weigh on equities.

Brent has come off its highs following the large drawdown of US inventories on Wednesday, with the $67 level now looking like firm resistance. We may now expect some consolidation in the $65-$67 range.  In forex, following the votes last night not a lot has really shifted on the Brexit front leaving the pound hovering near its highs but a little off. GBPUSD was last at 1.3285, having risen above 1.33 yesterday.

EURUSD was steady at 1.1380 having failed to break the key 50% Fib retracement. Broadly the dollar is doing the work here as it has come off its lows.  

IAGstrong performance in face of headwinds, questions remain 

This was a strong performance from IAG against a tough backdrop for the sector with higher fuel prices, air traffic control disruptions and foreign exchange headwinds. Operating profit and the dividend are a beat versus expectations. 

Fourth quarter operating profit came in at £655m, delivering operating profit of €3.23bn before exceptional items, up 9.5% from a year before. 

After completing a €500 million buyback last year, IAG plans on returning more than €1.3 billion to shareholders via ordinary dividends of €615 million, whilst also announcing a special dividend of  €700 million. Fuel costs jumped 18%, so the flat performance on total cost per ASK looks like a good performance.

IAG also announced it is buying 18 Boeing 777-9 aircraft, plus the option on 24, for BA., underlining its confident outlook. Based on current oil prices and exchange rates, 2019 profits are expected to be broadly flat with last year. If anything that smacks of being too cautious.

Questions remain though for IAG. It’s been a tough time in the last few days after being dropped by MSCI from its global indices after changing foreign ownership rules to meet EU rules ahead of Brexit. Passive funds have been forced to sell IAG shares and the stock has suffered. It’s also in a spat with the Civil Aviation Authority over a deal with Heathrow.  And the entire European short haul sector still has big question marks over demand and supply in 2019, not least because of Brexit. But having walked away from Norwegian, highlighting management’s capital discipline, investors should remain on side.

Shares have jumped 3.6% with investors shrugging off the slightly uncertain outlook and embracing the special dividend.

OPEC Preview: oil in a bear market

Week Ahead

OPEC Preview

December 5th, 2018

Production cut expected

OPEC and its allies convene in Vienna this week with expectations firmly favouring a supply cut in order to rebalance the market after the ramp in production seen ahead of the Iran sanctions. A cut in excess of 1m bpd seems assured, although it could be significantly higher than that. Anything up to 1.4m bpd seems anticipated, and therefore it may take more to significantly rally the market. A commitment to a longer and deeper cut will be required. Wire reports on Tuesday suggested a cut of at least 1.3m bpd is being worked on.

The meeting of the 26 OPEC and non-OPEC nations comes at a key moment for the market, with crude prices having slumped by around 20% or so over the course of October and November. The pace of that decline was startling and has undoubtedly forced a rethink of the increase in production we saw over the summer, particularly on the part of Saudi Arabia.

It’s not been alone: Saudi Arabia, Russia and the US have all been opening the taps this year. OPEC production in October hit the highest since December 2016 and was broadly flat in November. OPEC pumped 33.31m barrels in October, up 390k barrels from the month before. Saudi Arabian output is booming, climbing to a record 11m bpd. Undoubtedly this ramp cannot continue if the market is to rebalance given the declining expectations for demand growth.

Russian oil output hit a post-Soviet record high of 11.41 million bpd in October. However, this had dipped to 11.37 bpd in November. US production has surged to a record 11.475m bpd in September and is seen reaching 12.1m bpd next year (EIA). US production is now up 21% in the last year and the latest rise could mean more upward revisions to forecasts.

Trump factor

Donald Trump has repeatedly berated OPEC and others for trying to force up prices. Whilst there is pressure on the US-backed Saudi regime to acquiesce to demands to do nothing that would help lift prices, OPEC and its allies are set to push ahead. Although there are competing factions and priorities, no member wants a repeat of the collapse in prices four years ago.

US shale casts a long shadow. In particular, we must look at OPEC needing to act now to prevent a further squeeze on prices as more pipeline capacity comes on stream next year that would mean more US crude on the world’s markets. OPEC members are well aware that supporting prices is good for US shale producers, but they seem unwilling to go head to head again.

Qatar leaves

The question it leaves us with is to what extent OPEC is losing its relevance. Qatar may be a small player (approximately 2% of OPEC production), but it could suggest smaller suppliers are starting to lose faith in the Saudi-led cartel. Could it be the first domino? We must look at it in context of the regional powerplays. Whilst it may indicate a lack of consensus among members about cuts, it would be more likely to reflect the political tension between Qatar and its neighbours, in particular Saudi Arabia, which along with Egypt, the UAE and Bahrain is maintaining a trade embargo on the country. It would seem sensible for Qatar to distance its energy policy as much as possible from Saudi influence, particularly given its focus on natural gas over oil. It seems unlikely that Qatar’s decision will cast much of a shadow over the meeting or prevent an agreement.

Technical picture

Speculative positioning has turned south. CFTC figures show net longs down to their lowest in a year, down to 348k contracts by the beginning of November from 739k in February.

On the Brent daily chart, we see a firm bounce at the start of the week, with Brent breaking the downtrend resistance level and looking to push up to the 23.6% retracement of the recent down move at around $64.65. However yesterday’s failure to maintain any bullish momentum suggests there is little appetite at present for a pre-OPEC rally.

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