Two camps of Trump administration

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The trade spat of US with China is covered by the media in strikingly different modes at absurdly frequent short periods. On Tuesday, after the Bloomberg reported that the negotiating teams of the two countries may be close to finding a common communication code, the WSJ reports that the countries are about to resume talks, starting on the ground that the previous trade proposals were unsatisfactory.

But already on Wednesday, the clear horizon has again clouded, the administration wants to raise the proposed 10 percent tariffs on 200 billion goods to 25%, in an attempt to increase pressure on the Chinese partners to bring them back to the negotiating table. Today, the market is unstable, though weakly noticeable in stock index futures.

The White house also appears to be divided into two camps, defending different ways how to deal with China.

US Trade Representative Robert Lightheather convinced Trump of the need to get concessions from China through tariff hikes, while leaning towards trade-offs Larry Kudlow and Stephen Mnuchin are betting on the talks. Trump himself seems inclined to count on the effectiveness of threats, since he rejected results of June negotiations, when China agreed to increase purchases of agricultural products by 70 billion dollars and hydrocarbons from the United States.

The deal concluded with the European Union gave confidence to Trump, because the US seems to have overcome the main risk of isolation associated with maintaining a relatively hostile trade policy. The New and Old World have agreed to use WTO to resolve issues on theft of intellectual property, the forced transfer of technology and influence on the economic sectors that benefit from state control. All of these claims are related to China so the plans of Chinese government to create an economic alliance against the US were mildly not successful.

The proposal to raise tariffs from 10 to 25% is not final and may not enter into force if the public hearing deems it redundant. Nevertheless, the news about the increase in tariffs saw swift reaction among investors. Futures for the Dow fell, the yuan weakened against the dollar but quickly recovered. In my opinion, we should not discount the news about possible negotiations, as the “doves” in the White House will continue to do their work. The new tariffs for $200 billion should come into force on August 30 and it will be very unreasonable for China to test the limits of their economy simply by ignoring threats. Therefore, we expect signals about a new round of talks and a relief rally in the yuan and the stock market in the US.

The flexibility of the Bank of Japan in the asset purchase program has borne its first fruits. After the Central Bank announced that it allows wider fluctuations in the profitability of 10-year JGB, yesterday’s revival of demand at the meeting turned into sell-off and the yield jumped to 13 basis points. Revived bond trading is aimed at getting profit from Central Bank interventions, since according to the statement, the regulator will prevent a sharp increase in yields. For the yen, the BOJ’s fresh stance is clearly bullish, as the transition to flexible yield targeting is a signal to policy tightening, though in distant future.

Today the meeting of the Fed is due where Fed funds rate is expected to stay untouched. The expectations of the two rate hikes in the second half of the year are solid, so Fed comments will be examined in relation to the potential inflationary effect of tariffs, which, with growing Trump rates, may take a threatening breadth for the economy. Milder growth forecasts in 2019 can provoke dollar sell-off, while the dollar could rise if the Fed really sees the possibility of accelerating inflation as a result of tariffs.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.
 

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Gold – Does History Repeat Itself?
Gold price has extended buying momentum on Tuesday, developing the takeoff from $1,500 seen on Monday. I guess the explanation for the move lies primarily in the following chart:



As you might expect, I’m talking about inflation expectations in the United States. I also raised this topic in my yesterday post. Since last Friday, average expected inflation over the next five years has jumped from 0.86% to 1.23%. It is well known that gold and the inflation factor in pricing of the dollar are inversely related, which is based on the simple idea that an asset that loses its purchasing power should become cheaper in relation to the asset that retains it.

The latest jump in gold can be explained by the following factors:

  • Fundamentally determined weak prospects and an increased expected variance of returns on risky assets;
  • Rising concerns of inflation outbreak in the United States thanks to “unlimited” asset purchases by the Fed, which also expanded the range of securities to include corporate and municipal bonds and is now basically in “whatever it takes” mode;
  • Basic supply/demand change: expectations an increase in the money supply in the economy contributed to the currency weakness against other majors (including gold) which outweighed demand driven by “flight into cash” motive;
If you look at how gold behaved during and after the previous crisis, there are some parallels that we can draw:



At that time, there were debates whether QE would lead to an acceleration in price growth or not, i.e. at the beginning of QE, there were expectations of this, which was priced in accordingly in the price of gold. I emphasize that QE’s novelty as a policy measure at that time was a volume of guaranteed bond purchases (the Fed achieves its interest rate targets by the same open market operations – treasury purchases that change supply of bank reserves). The novelty of the current measures, in my opinion, is in their volume again, which has potential to lead to similar gold response.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Narrowing Range in Oil Could Suggest Sweeping Move on the Cards
Stock market euphoria, which is also expressed by a global dollar dump, does not resonate with crude oil: WTI trades in a narrowing range around the $23 mark, remaining unimpressed by the dollar weakness and rebound in risk assets:



Such a pattern usually precedes a strong move and there are some reasons to expect the market to lose its temper. Government actions around the world are increasingly saying that countries are making bets on the experience of Wuhan in suppression of the outbreak – organizing home quarantine for at least two weeks. This is accompanied by serious short-term economic losses, including a drop in demand for fuel and a decrease in manufacturing and production activity because of forced decreased labor supply. This week the second most populated country in the world and the largest oil consumer, India, announced a 21-day full quarantine, which is likely to force experts to revise consumption forecast even more to the downside.

Data on Thursday showed that the number of initial unemployment claims in the US rose to a significant 3.3M. The response of the stock market showed that the downside surprise was quickly absorbed. The number of confirmed cases worldwide increased by 13.43% on Thursday compared with the previous day after several days of consistent decrease in the growth rate:



The head of the IEA Fatih Birol said that global oil demand is now “in a free fall”, and the glut is deepening due to the price war between Russia and Saudi Arabia. According to him, 3 billion people are locked down, as a result, oil demand may fall by 20 million barrels per day (almost 20%). Goldman gave similar depressing figures for March and April (10.5M b/d and 18.7M b/d) and it is clear that bigger and longer lockdowns should shave off more near-term consumption demand. That’s why “updated” EIA forecasts offer even gloomier view. In the near-term prices may be supported by the decision of the US government to restart economy earlier as Trump promised. Rumors about the move should be kept on the radar.

Oil trader Vitol Group expects that demand drop will accelerate over the next three months and will not fully recover this year.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Investors Eye Unemployment Claims as the key Proxy of Stress of the US economy
Oil

Today we’ve seen relatively robust upward swing in oil as the market did not wait for negative news but were offered solid support thanks to a number of positive catalysts, including:

  • Rumors that China has started to fill strategic reserves taking advantage of the low oil price. The volume, duration, speed of purchases was not made public, so the news played out as a very general bullish catalyst.
  • Trump tweeted that Saudi Arabia and Russia may again commit themselves to coordination of oil supply. The deal, according to Trump, may take place in the coming days, which is consistent with reports that Trump held phone talks with President Putin during which they “discussed oil market.” It also became known that Trump invited US oil producers to the White House to discuss the situation, in addition, Texas companies turned to the state administration to discuss possible output cuts.
  • The Baltic Exchange data shows that the cost of transportation of US oil to China reached $10 per barrel, i.e. half the price of a barrel of the American benchmark WTI.


Cheaper grades of oil in the US are currently trading at absurd prices for producers which is increasing chances that the market may soon be surprised with substantial output curbs.

  • At the same time, Saudi Arabia is not going to stop – kingdom production reportedly exceeded 12.5 million b/d, which, however, is not a surprise for the market.
U.S. dollar

The focus is now on the growth of unemployment due to self-isolation measures, with initial unemployment claims as the key proxy indicator. The estimated March reading is 3.7M (+ 400K compared to the March 21 print), but risks are skewed to the upside, since the number of regions where self-isolation regime have been introduced is rising rapidly while it is difficult to calculate precise figures due to difficulties of Labor Department in processing a huge inflow of applications. More than 80% of Americans are now in some way affected by quarantine measures.

Huge spending package from the government which includes unemployed benefit of $680 per week (or 17 per hour for 40-hour week) may contribute to the growth of “intended unemployment” which is an unwelcome consequence of emergency fiscal stimulus that can hamper rebound of labor supply after quarantine measures are lifted. Dollar is expected to move lower after the release pricing in growing weakness of the US economy.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Is it Late to go Long in Gold? Real Interest Rate Path in the US Suggests “no”
The first signs of consistency appear in the decrease of the number of confirmed cases of Covid-19. The whole near-term market optimism hinges on that trend so it’s worth to keep a watchful eye on it. Following the abrupt daily drop in the number of new cases from peak 98135 to 75956 on April 5, it fell the second day in a row to 68608, extending relief rally in world stock markets today:



Asian stocks have ended session in green, key European indices advanced by an average of 5%. US stock index futures have been also trading higher on Tuesday. Thanks to upbeat sentiments in the oil market, it is very likely that the bullish momentum in EM including Russia will be extended for the rest of today’s trading session. The ruble is expected to continue to strengthen with the main goal of 75 rubles per dollar, passing intermediate support without much effort.

Some questions are caused by the rise of gold coexisting with the rally of stocks which are considered to be the asset classes reacting to opposite market sentiments. But taking a look at the dynamics of TIPS yield (yield on inflation-protected treasury bonds), we can see that the real interest rate in the US seems to play a big role in gold pricing currently:



The real interest rate (nominal rate minus expected inflation) and gold are inversely related, since the decrease in the first reflects the deterioration of investment alternatives in the economy and decrease in the purchasing power of money (inflation), while gold serves as protection for all of this.

The nominal interest rate is likely to linger for longer near the zero level due to cautious Fed unwilling to touch the interest rate, while enormous fiscal incentives from the government should have strong inflationary effect (due to the fact that the money will also fall into the hands of the poor which have much higher propensity to consume). The real interest rate will probably decrease further and based on the dependence above, the likelihood of gold extending the rally is pretty high, making it attractive medium-term bet.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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US CPI: Downside Risks Prevail
Broad and core US inflation printed lower than expected in March reflecting downward pressure from fuel prices, narrowing demand for apparel, transportation costs but only moderate upside pressure in other components. On the side of negative risks for CPI we can note explosive growth in unemployment and deepening fuel price deflation because of the oil price shock. The massive anticipated increase in government spending including tax reliefs and transfers to impacted households is likely to create inflationary pressures on certain goods including food while easing monetary policy is expected to have minor impact on prices due to decreasing supply and demand for loans.

The broad CPI declined 0.4% compared to February, holding back annual inflation which amounted to 1.5%. The fall was stronger than expected (-0.3%), price declines were led by fuel prices (-5.8%), transportation costs (-2.9%) and price for apparel (-2%).

The rest of consumer categories showed muted inflation pressure. The price for tobacco products gained 1%, prices for medical services increased by 0.4%, food inflation amounted to 0.3%. Rental prices rose 0.3%. Inflation in services sector decreased by 0.1% in monthly terms and amounted to 2.1% in annual terms against 2.4% in February.

Considering the negative risks for inflation, the biggest of them is collapse in oil prices, which feeds into retail prices for gasoline, utilities, producer costs what in turn limits inflation on final goods.



Travel and transportation curbs will adversely affect housing prices, hotel accommodation prices, and rental rates. The weight of this component in the CPI is 33%.

Demand for services usually depends on the dynamics of the wages of the population. The explosive rise in US unemployment (+17 million over the past three weeks) is likely to translate into price deflation in this sector. The weight of this component in the CPI is 26%.

The minutes of the March Fed meeting revealed that officials do not expect inflation to accelerate in the near future even after a possible restart of the economy in the summer or even if lockdowns continue until the beginning of next year. According to the report, in all scenarios, inflation is expected to weaken, reflecting underutilization of resources and the drop in oil prices.

Loosening access to credit won’t lead to perceptible increase in consumer inflation unless, in fact, credit expansion takes place, which depends on the desire of banks to issue loans and on the demand of households for them. The main effect that we can expect is asset price inflation with first signs of it expressing in the latest stock market rebound in response to Fed actions.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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IEA April Energy Outlook Pressures Oil Producing Nations to cut Bigger and Faster
The People’s Bank of China cut its medium-term lending rate for financial institutions on Wednesday to the lowest level on record. This is far from “fine-tuning” of monetary policy, but rather a powerful stimulus of the banking sector, which raises concerns about smoothness of economic recovery. The government tries to deal with the fallout of coronavirus mainly by taking the gloves off of the banking sector.

The cut of the lending rate for commercial banks should bring similar relief in financing for firms and households that were dragged under the mills of epidemic.

Commercial banks in China can now borrow at a record low rate of 2.95%. This credit facility was launched in 2014 and the latest rate cut amounted to 20 basis points which is relatively big cut. By lowering the rate, PBOC tries to spur the competition of commercial banks in making loans, which in theory should lead to a further decrease in the prime loan rate – benchmark loan rate offered to first-class borrowers:



Trade data from China released on Tuesday beat expectations. Exports decreased by 6.6% against expectations of -13.9%, imports fell by only 0.9% compared with the forecast of -9.8%. A smaller than anticipated decline in China foreign trade contains pessimism about the virus impact on world trade which supported short-term positive market sentiment on Tuesday. The data on export and import prices in the US and Indonesia’s foreign trade in March laying the groundwork for better estimates of world trade recovery.

The risk-off wave as a next big test for the Fed

China will release March GDP, retail, and industrial production data on April 17. Weak figures will probably force markets to revise the pace of economic recovery and energy consumption outlook to the downside, restraining upturn in oil. The price resumed decline despite the pledge of many oil producers to reduce output during which the countries agreed to reduce production by 10 million bpd from May 2020. The IEA’s April outlook included dire predictions of demand recovery: the agency estimates that demand in April will fall by 29 mn b/d, which is almost a third of world consumption. Even if lockdowns are weakened in the second quarter, underconsumption for 2020 will amount to 9 mn b/d which is just 1 mn b/d less that max output cuts expecting to last only a couple of months:



EIA valuation exceeded market expectations negatively

Countries that set lockdowns earlier, such as Italy, announced on the weekend that quarantine would be extended until May. Recall that Wuhan was unblocked only 63 days after the introduction of the measures, so one-month social restrictions imposed in other countries are likely to be too short to be effective. They will probably also need to be extended.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Oil: Near-term Pressure may Remain in Place Because of Storage Issues
It is not surprising that the outlook for front-month oil futures, especially for June, remains bleak as some market participants continue to price project shocking drop of May contract price to June contract. Recall that May WTI contract dropped below 0 on April 20 and the NYMEX decided to use the negative settlement price on April 21. This forces investors to drop one of the fundamental concepts of risk limit in WTI futures market (the loss on long futures position is no longer limited to trading equity, even in “normal” market conditions).

The story also reveals the real degree of oversupply and importance of limits of Cushing storage hub, which underlies the mechanism for settlement of WTI deliverable futures. Despite the fact that the government data indicates that the storage is only 77% full (~ 59 out of 76 million barrels), Reuters reports that the remaining storage was fully “reserved” in mid-March. The storage issues should accelerate rebalancing of the market in the near future.



At the same time, the fact of possible permanent loss of some US oil output, financial constraints limiting proper supply response to demand rebound, create an upside risk that supply rebound won’t keep pace with recovery of consumption after lockdowns are lifted. This is a favorable fact that strengthens contango in the market. However, much depends on the willingness of the US government to save the sector and jobs.

Negative prices is an unlikely threat to front-month Brent contracts, because firstly, deliveries on Brent are carried out by sea, in contrast to the “landlocked” WTI market, where Cushing oil delivery is a part of settlement mechanism on deliverable WTI futures, and secondly, Brent contracts are settled in cash, so with the approach of expiration date there should be less pressure on buyers to cover long positions.

The storage in Cushing at the current rate will be likely filled up in mid-May, with adjustment for producers which are cutting production – around the end of May. This means that pressure in front month contracts, ceteris paribus, may remain for a week or so. When the storage is full, producers will have to curb output to approximately equal the loss of demand.

OPEC held another teleconference yesterday, together with comments by IEA head Fatih Birol, market expectations are emerging that countries that joined OPEC+ pact may begin to cut production earlier than planned in May, though this looks like a late measure. The meeting of Texas Railroad Commission ended with no positive results for the market, the next meeting is scheduled for May 5. API reported an increase in stocks of 13.2M barrels, this is the fourth consecutive week when stocks are growing at more than 10M barrels per week. Cushing reserves have increased by 4.91M barrels.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Oil and US Durable Goods Data Paint Mixed Picture About Recovery
Oil: An Unfinished Story

Oil prices renewed decline this week, June WTI contract dropped by more than 15%, Brent fell by 7.5%. The market expects OPEC to start cutting production later this week. Given fragile state of the market, some countries decided to start cutting output ahead of the agreed date in the OPEC + pact, including Saudi Arabia. Although bringing forward production cuts should positively contribute to market recovery, short-term market sentiment is under the sway of both near-term fundamental imbalances (the unresolved problem of oil storage in Cushing, highly uncertain pace of demand recovery) and psychological factors (fear of being on wrong side, FOMO shorts)

Drilling activity in the United States declined last week, Baker Hughes reported, pointing to a reduction in the rig count by 60 to 378 units:



The number of oil rigs is quickly approaching the level that we observed in 2016. Since mid-March, the number of rigs has shrunk by almost 45%, which means an imminent coming decline in US output which should additionally ease supply pressure on the market.

Another important component of current expectations in the oil market is the information related to signs of demand recovery. The worst for global oil demand appears to be in the past and it is reasonable to assume that it is reflected in the price. Data on volumes of oil refining in China gives benign indication of a welcomed rebound. Independent refineries in Shandong province increased refining to record levels while the data from the analytical agency SCI99 shows that refinery capacity utilization last week increased to 72.67% (+ 0.71% compared to the previous week). However, more importantly, compared with February, capacity utilization increased by almost 30% (the lowest point in February was approximately 42%). This suggests that oil demand in China is growing at a relatively steady pace.

USA: Strange CAPEX Stability

Orders for durable goods fell 14.4% in March YoY, which seems to fit into the overall picture of the crisis and not particularly noteworthy information. However, one of the components of the indicator, namely, orders for capital goods excluding orders in the civil aviation sector, showed strange stability in March:



Not taking into the account distressing situation with Boeing (13 new orders and 295 canceled), it seems that firms in the US were in no hurry to cut investment plans in March, as can be seen from the stable dynamics of the red curve in the above chart. The change relative to March 2019 was + 0.1%, but strangely it wasn’t reflected in production surveys from ISM (49.1 points) or from the Philly Fed (-12.7 points in March). It was expected that the reading will print much lower at -6.0%.

The Fed is closely monitoring the dynamics of orders for capital goods, as it reflects the expectations of financial managers regarding future demand for their goods. Taking “forward-looking” information into the account helps the Fed to not be lost in policy responses solely to past events. It is likely that firms were not able to assess the full severity of the lockdown in March, but there is also a chance that impact of lockdowns may be somewhat overstated (if we assume that financial managers have more information than we do). In any case, a positive surprise creates the basis for less gloomy figures for the first quarter of GDP, which will be released next week.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Oil: Historical Price Inefficiency Thanks to USO ETF
The fall in oil prices continued on Tuesday, the June WTI contract was offered a short-term support at around $10.60, front-month Brent contract is trading below $20 per barrel. With such scary nosediving moves the question arises about the true cause of the wave of liquidation which started on Monday. Settlement of June WTI contract will take place on May 19 and, in general terms, the core underlying problem is still an unresolved issue of WTI physical delivery. However, the fall of oil price below 0 due to a lack of liquidity drew market attention to the vulnerability of oil ETFs, which need normal liquidity to transfer positions to the next contract month (which is called rollover).

Of greatest interest are the positions of USO, the largest oil ETF in the United States. It came to the attention of traders after the April 20 carnage due to the fact that a fairly common trading strategy for commodity ETFs – holding front-month futures and sequentially rolling them over to the next month, began to have sharply increased risks. Although the USO rolled over into the June contracts some time before the collapse of May WTI, same delivery issues for June contract were creating huge risks for investment position of the fund in terms of opportunity for safe roll-over. On April 23, the fund said that it is going to change its holdings from June contracts to the following composition:



To change the composition of its investments, the USO has to entirely sell its June contracts and buy the ones indicated on the chart. But what is most remarkable, in the same statement, the USO indicated exact timeline of alteration of its investment portfolio (from April 27 to 29, by 33.3% every day).



In simple words, the largest oil ETF in the US has clearly indicated what it will sell and what to buy. Well, how could you not front-run them here? Basically, it is probably the biggest and most evident market inefficiency for decade.

And the oil sell-off which began on April 27 is most likely a result of the fact, that a major participant, in this case the USO, announced in advance that it would sell all the June contracts to which it had previously been rolled over. The dovish pressure from other market participants has created a large speculative wave, which is only gaining momentum, as another 66.6% of the USO contracts in June will be sold today and tomorrow.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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ECB Meeting preview: Wrong Words in a Wrong Time
The April ECB meeting has all chances to become a factor of support for EURUSD. At the March meeting, Lagarde failed to show off ECB’s firepower at a critical time for the economy, forcing investors to demand extra returns for holding Euro (i.e. creating risk premium in it). They obviously expected “whatever it takes” tone from the ECB president but Lagarde didn’t live up to expectations. This ambiguity became a bearish factor for EURUSD. If Lagarde elaborates properly on ECB’s rescue plan, including details on the pandemic asset purchase program (PEPP) the risk premium in Euro will probably vanish helping the currency to outperform USD in the near-term.

Two key aspects of the meeting to pay attention are updates on pandemic asset-buying program (PEPP) and ability of Lagarde to reassure markets that ECB has enough ammo and won’t hesitate to use it. It is clear that the policy response of the ECB in March was less profound compared to the Fed:



And although interest rates cuts and increase of QE operations should normally lead to decline in national currency this doesn’t happen when economic conditions do not favor expansion of credit (which is the main driver of money supply growth) so positive QE effects (like bringing ease to funding markets) become a factor of currency strengthening, leading to capital inflows! The Fed and dollar performance in March perfectly support this reasoning.

The PEPP program, which is so much talked about now, can be increased both in breadth (from the current 750 billion euros to 1.250 trillion) and in depth (including the purchase of bonds of the so-called fallen angels – former investment-grade companies falling into speculative category). If this happens at the meeting on Thursday, it will be a big bullish factor for the euro, but given that updated economic forecasts from the ECB will not appear until June, the expansion of PEPP may be delayed. One of the simple but useful indicators of risk for the Eurozone economy is the yield on Italian bonds and its recent decline from 2% to 1.7% suggests that the anxiety about problematic debtors has somewhat eased. This increases chances that the ECB won’t rush to expand PEPP in April, but a signal that this will be done in July will be nevertheless a moderate positive factor for EURUSD.

As for the press conference with Lagarde, attention should be paid to the comments regarding inflation outlook, economic growth, interest rate and QE paths. In March, Lagarde surprised markets with a rather neutral statement that “inflation is expected to rise in the medium term,” so Lagarde’s remarks on Thursday that the ECB is moving away from the inflation target is a baseline scenario and should not be surprising. No changes are expected in the interest rates and QE; comments on economic growth are expected to focus on confirming sharp slowdown in March and April. In general, the trading idea for the meeting on Thursday concentrates on Lagarde’s ability to correct communication mistakes made at the March meeting.

Reducing distance between the interest rates of the Fed and the ECB, declining demand for dollar as a safe haven may determine fundamental advantage of EUR over USD in the medium term.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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EU Data: Two weeks of Lockdown and -3.8% of GDP Decline in 1Q
GDP

Recession in 2020 will go down in history as a deliberate economic sacrifice of governments in exchange of greatly reduced uncertainty. Incoming data shows that this step came at a great cost. Eurozone GDP fell by 3.8% YoY in the first quarter and it is only with lockdowns affecting economy just the last two weeks of March! The fallout is expected to spill over into the second quarter as the economy has been under extreme pressure for the whole month of April while weakening of sanitary restrictions will occur slowly and with extreme caution. We cannot also rule out long-term damage to consumer confidence which is yet to reveal itself in the data. The economic downturn is likely to exceed the magnitude of the first quarter, so the season of gut-wrenching data has probably just started.

French output fell by 5.8%, Spain – by 5.2%, Belgium – by 3.9%, Austrian – by 2.5%. There is a direct relationship between strictness of quarantine and impact on GDP as the latter reflects the degree of suppression of economic activity as well as restrictions on mobility of consumers. It means that German economy probably suffered less damage than France or Spain because the lockdown was less strict.

Unemployment

Unemployment in the Eurozone rose from 7.3% in February to 7.4% in March.



The increase in unemployment turned out to be less strong than anticipated both due to the labor market rigidities ( which in turn are caused by higher costs of hiring and lay-offs, prevalence of short-term working schemes), and due to smoothing of the effects of two-week quarantine in March by two “normal” weeks at the start of the month. Due to the above-mentioned features of the labor market in the Eurozone, it is precisely the dynamics of unemployment that will explain the speed of recovery and affect market expectations for economic rebound. With rising unemployment in the Eurozone, the likelihood of a permanent blow increases.

Consumer Inflation

April inflation in the Eurozone fell to 0.4%. As in the case of GDP, the accuracy of the figures is still in question due to difficulties in collecting data. Core inflation, which excludes fuel prices, fell from 1% to 0.9%, while measuring it for sure was much more difficult than usual. PMI surveys for the block showed that firms reduced prices to increase sales, but so far this is not visible in the data.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

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Real Unemployment Rate in the US Could be Much Higher
Non-Farm Payrolls reports released on last Friday showed that US basic labor market metrics have deteriorated, albeit at a slower pace than expected. Unemployment rose to 14.7% (vs. 16.0% forecast), jobs count suffered steep contraction by 20.5 million (vs. 22 million forecast). It would seem that the less downbeat report prompts us to revise devastating impact of lockdowns and the outlook for labor market recovery in May and somewhat weakens skepticism about the S&P500 rally, however details of the report show that this conclusion may be premature.

Firstly, recall that the BLS defines unemployed as a person who lost his job but is in active search for it. The part “is in active search for it” basically forms an additional filter because there is also a part of the unemployed who are demotivated to look for a job and it is reasonable not to count them as unemployed when the labor market is in good shape, because they deemed to be demotivated for reasons that economists do not particularly care about (sufficient income, health problems, etc.). It is assumed that they do not reflect/impact labor market conditions. But it is natural that during a downturn, an increase in the number of demotivated workers most likely indicates an increase in the number of “desperate” unemployed (want to a job but gave up looking for it), which should be effectively counted as unemployed because their status does reflect worsening labor market conditions. That is, there are also unemployed “outside the workforce”, which the basic unemployment rate (the headline 14.7%) doesn’t capture, but which are important to count. Looking at the collapsed level of labor force participation, we can conclude that the number of these desperate workers has increased:



Since February, 8.1 million people have moved out of the labor force and based on the analysis above, there are likely to be many “true” unemployed people in that category. Headline figures (14.7%) doesn’t count that.

Secondly, the importance of secondary indicators of employment, such as “employed, but absent from work for other reasons”, “involuntary part-time employment” unexpectedly increased. These indicators increased to 7.5 million and 6.6 million respectively. In my view, the fact that the BLS couldn’t count the gain in the first indicator as the gain of unemployed is pure formality, although it saw sharp increase during the lockdown period so it’s not hard to guess which were those “other reasons”.

So, let’s update our calculation of unemployment: 23.1 (basic BLS figure) + 8.1 + 7.5 + 6.6 = 45.5 million. Dividing this value by labor force (164.5 million) we get unemployment at 27.5%, that is, almost twice as high as the official indicator at 14.7% and higher than broad U-6 indicator (which include demotivated workers) which rose to 22.5% in April.

The April report did not have high hopes in terms of the ability to move the market, which, in fact, could be inferred from the calm market response to huge gains in the initial unemployment claims. However, with the country’s exit from the lockdown, the situation may change. In addition to the initial unemployment claims, continuing claims also come to the fore, which will be direct measure of recovery of employment. Much attention should be paid to negative surprises in continuing claims, as they will likely indicate permanently lost jobs, i.e. long-term negative effects of lockdown on the US economy which is of course not priced in the current S&P 500 rally.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Raising Price, Cutting Output: Mixed Signals from Saudi Arabia
Saudi Arabia underpinned oil mood on Monday announcing additional output cut by 1 million bpd. starting in June. The Kingdom’s output is expected to decline to 7.5 million bpd., the lowest level for almost 20 years. The underlying motive is probably to speed up market rebalancing and hence price recovery. It is worth mentioning that the decision of the Kingdom soon followed the telephone conversation of Trump and the King of Saudi Arabia. Brent jumped 5% on good news, but the bullish momentum proved to be short-lived as the price closed below the opening. Given the news that Saudi Arabia decided to rise OSP for June, the extra cut may seem as a weird move since by cutting output producer signals about expectations of declining demand, while charging higher prices is usually a sign of improving demand picture.

The Kingdom has successfully passed the baton of additional voluntary production cuts to other Middle Eastern countries, in particular Kuwait and the UAE which decided to follow suit and said they will reduce output by 100 and 80 thousand bpd in June, respectively. There is an aspect of the OPEC+ deal which explains limited optimism about the news: uncertainty in commitment of the individual participants to output cut targets. In other words, these additional output cuts may either surprise to the upside later, signaling about over-fulfillment of the plan or play out as a downside surprise if subsequent data reveals poor performance of other participants. For example, Iraq has historically turned out to be the least “diligent” member of the cartel (in terms of following a collective agreement), so there are concerns that the country won’t be able to deliver the output cut by 1 million b/d.

Today we expect the report from US Department of Energy (EIA), which will contain a short-term outlook for the oil market. It will be interesting to see how the agency adjusted their projections considering recent changes such as collapse of drilling activity and fairly rapid decline of the US production over the past few weeks. OPEC is going to release its monthly report on Wednesday and on Thursday the monthly EIA report is due which is of particular interest because of extremely vague demand picture and lack of reliable estimates of demand recovery.

The Chinese statistical agency reported that annual inflation in April was 3.3%, which is less than the forecast of 3.7%.



But looking under the hood we don’t see signs of severe slack in consumption: decelerating food inflation accounted for a good part of the slowdown in the aggregate indicator. Core inflation which excludes volatile components such as good and fuel was up 1.1% in annual terms. At the same time, production price index indicated a deflation of 3.1% against the forecast of -2.6%. Given the reliance of manufacturing sector to foreign demand, PPI points to weakness in foreign economies.

Easing inflation pressures gives a firm nudge to the Central Bank to proceed with a new round of monetary easing, which should bring some relief for local and foreign risk assets. The quarterly PBOC monetary policy report released over the weekend indicated a growing bias of the Central Bank to strengthen liquidity support for the economy in the near future.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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Oil and Gold: Review of the Key Drivers
Oil: Contango Eases

Tuesday WTI gains, which helped the price to close above $25, set the stage for modest Wednesday rally. While the market ponders over next leg of the rally, price difference between the December and June WTI futures continued to narrow:



Declining market contango indicates several effects are in play:

  • Abating concerns related to the storage and transportation of WTI, including in Cushing (more on that below);
  • Oil funds completing the shift from near-term to more distant contracts (change in USO positions at the end of April as an example);
  • Easing supply pressure thanks to output cuts from OPEC+ deal, market-driven output cuts in the US and voluntary cuts from some Middle East countries like Saudi Arabia and UAE.
  • Slow recovery in demand for near-term oil supplies.
The American Petroleum Institute said yesterday that oil reserves rose by 7.5 million barrels, but most interestingly, Cushing inventories, according to the agency’s estimates, fell by 2.26 million barrels. If the EIA confirms this estimate, it will be the first inventory reduction since February. Negative change in Cushing inventories basically means that less oil arrives there than taken from it. It reinforces our view that production declines and demand grows in the US. In addition, this limits pressure on prices based on concerns that the June WTI contract may repeat the story of the May contract with the approach of expiration date.

As for EIA’s short-term energy outlook report, the agency has revised down its forecast for US oil output. The agency expects that the average production for 2020 will decline by another 70 thousand barrels to 11.69 million barrels (-540 thousand bpd in annual terms). The agency also predicts a decline in production of almost 800 thousand b/d in 2021.

XAUUSD: risks are shifted to the downside

In gold, we observe some stabilization near $ 1,700 per troy ounce; technically, recent price action on 4H timeframe forms triangle, which is usually a sign of breakout:



There is strong evidence that Gold pricing depends a lot on inflation expectations in the US:



This chart suggests some “hyperinflation fears” may be priced in Gold which are subject to revision with the latest inflation data.

Core inflation in the US in April fell by 0.4% MoM for the first time in 38 years, showed the report on Tuesday. Firstly, this is evidence of a severe drop in consumption, which tends to regain losses slowly. Secondly, this indirectly indicates that firms have accumulated record inventories and may be soon forced to make discounts, which is another factor of pressure on consumer prices. In my opinion, with the advent of clear deflationary trend in the US, gold loses the main growth factor. Soon we can see a “sell-off” of hyperinflation fears from the Fed’s policies and fiscal stimulus, as, in fact, evidence grows that they won’t materialize soon.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% and 70% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 
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