Morning Commentary: This One Will Hurt

Foreign Exchange - Morning Commentary
This One Will Hurt
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Through the first quarter of the year, crude prices have fallen ~70% and currently sit around 18-year lows.  This steep decline in oil prices can be directly attributed to both the oil war between Saudi Arabia and Russia as well as the demand shock due to COVID-19 containment measures.  With regards to the first point, today marks the end of agreed production limits by OPEC and its allies.  As for COVID-19 headlines, the markets find themselves back in risk-off mode as Trump’s admission of a “painful two weeks” to come represents a stark change in tone from previous guidance.    

Looking back as the oil markets, the US has recently become a net oil exporter.  Nevertheless, energy goods consumption still dwarfs energy-related capex as a percentage of GDP.  As a result, a decline in oil prices should serve as a net positive for the US economy.  

On the energy capex side, oil prices have dropped below the operating costs for many firms, meaning these firms may not only be defaulting on existing loans but could also file for bankruptcy.  Per the Dallas Fed energy survey, only 15% of Texas oil companies can survive more than a year with WTI prices below $40/barrel, opening up the risk for companies to completely shut down. 

On the consumption side, GDP should benefit from a pickup in additional consumption due to lower energy costs that lead to more discretionary income.   During normal times, consumers would use the extra income to spend more on discretionary goods but, of course, these are not normal times.  COVID-19 containment measure have not only resulted in less demand for oil but also travel, entertainment and other discretionary items.  

Bottom line: Necessary containment measures have made material changes to the consumer’s consumption basket.  As a result, the current decline will lead to an outsized shock to the economy without much of a consumption offset.   
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • This virus situation in Italy appears to be stabilizing with government officials stating that the country has reached “a plateau in the contagion phase.”  
  • The ADP jobs report showed the US economy losing less jobs than expected with the report coming in a -27K against expectations for a -150k decline.  Tomorrow brings initial jobless claims where another 3.5 million claims are expected to be filed. The government’s jobs report for March will be released this Friday.  Current market consensus is for a -100K print.  Regardless of where the March number comes in, expect April’s report to be even worse. 
  • US ISM manufacturing PMI fell less than expected, coming in at 49.1 versus expectations 44.5 print.  However, order and employment at US factories in March contracted at its quickest pace in 11 years.  
  • The Eurozone manufacturing PMI number came in roughly around consensus, printing 44.5 against expectations for a 44.6 print.  German manufacturing PMI also came in roughly around consensus, printing 45.4 against expectations for a 45.5 print.    
  • UK manufacturing PMI beat expectations, coming in at 47.8 against expectations for a 47.0 print.      
  • China’s Caixin manufacturing PMI beat expectations, printing 50.1 against expectations for a 45.0 print, reflecting a reopening of the Chinese economy.  Additionally, China’s State Council met yesterday and has pledged more stimulus to support the economy.      
  • RBA minutes were released for its special March meeting where it lowered rates to the effective lower bound and implemented many unconventional monetary policy measures.  The minutes emphasized the board’s desire for lower funding costs to support the economy once the virus is contained.   
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