Tuesday, December 16, 2014
It’s all about oil and Russia today, with markets responding to the evolving picture out of Russia. These developments seem to have stolen the headlines from the U.S. Fed, which starts its two-day session today.
Markets weren’t impressed with Russia’s shock-and-awe move of raising interest rates by 650 basis points to 17%. The central bank was trying to restore confidence in the ruble and stem further capital flight, with both getting hit by western sanctions and falling oil prices. But the market impact today has been the opposite of what the Russian authorities intended. Seeing this as panicky move, investors are dumping Russian assets, pushing the exchange value of the ruble to a new low versus the dollar.
The unfolding Russian situation is just one part of the much bigger oil story that has been roiling the global markets lately. As we have been stating in this space repeatedly in recent days, the oil price drop is a net positive for the U.S. and global economy.
But the reason why markets find the ongoing oil drop unnerving is the read-through the price action provides about the global economy. Contagion-related fears emanating energy sector high-yield bonds also get mentioned in in the oil story. But the more worrying aspect of the oil picture is what it tells us about the global economy.
Please keep in mind that the oil price drop isn’t solely a result of increased shale-centric supplies from the U.S. — it is also reflective of soft demand as a result of global economic weakness. We have been aware of the uncertain outlook for the global economy for quite some time, with Europe fighting deflation, Japan still struggling and China losing steam. In fact, the improving outlook for the U.S. economy is in contrast to the same for all its trading partners. That is the reason why U.S. monetary policy is moving in a different direction from what is expected elsewhere among the major world economies. The resulting strength in the U.S. dollar has been a contributing factor to the oil price decline.
The recent cutbacks to global oil demand by organizations like the OPEC, the International Energy Agency, the U.S. government’s Energy Information Administration and others is a reflection of global economic growth moderation. Of particular concern has been the slowdown in the energy-intensive Chinese economy, where the manufacturing sector has been steadily losing ground. In fact, Chinese weakness is a big reason why global oil demand hasn’t been able to keep pace with rising supplies.
In corporate news, we have dividend hike announcements from a couple of bellwether operators – Boeing (BA) raising its payout by 25% and 3M (MMM) by 20%. In other news, Spain’s Repsol is buying Canada’s Talisman (TLM) for $8.3 billion, a 60% premium over Talisman price over the past month. There is growing hope that the falling oil prices will result in a new wave of consolidation in the oil patch. This deal must have been in the works for quite some time, but perhaps it will kick off this process in the general oil space.
Sheraz Mian
Director of Research
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