by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equities are rising this morning as earnings season begins.  As our numbers above indicate, earnings are expected to be robust and the releases this morning confirm that outlook.  Here is what we are watching:

Return to TPP?  All presidents learn on the job; there really isn’t any earlier position that prepares a person for the rigors of the presidency, although state governorships are probably the best training available.  Where one sees this clearly is in presidential debates when an incumbent is running for a second term.  The “newbies” are all talking about all the great things they will do, while the current president looks at them with eyes that suggest “you think it’s that easy?”  Both candidates wanted to kill TPP and TTIP.  It looked like a political no-brainer.  Americans had employment insecurity and the last thing they wanted was more foreign competition in the form of imports.  But, apparently neither candidate understood the real reason these trade deals were cobbled together.  If both trade deals were in place, the U.S. would have been the center of two enormous trade blocs.  Any nation outside the blocs would have been at a deep disadvantage.  It would have forced China and Russia, in particular, to enter the agreements essentially on America’s terms.  Instead, both candidates focused on the impact on U.S. jobs.  Some sectors of the U.S. job market would have likely been adversely affected by trade and thus both candidates promised to end the deals.  Now, President Trump is realizing that if an overarching goal of U.S. foreign policy is to manage and contain China, then TPP would be a really useful tool.  We would not be surprised to see the administration reverse course on TPP and, despite this morning’s comment to the contrary, the other 11 nations renegotiate parts of the agreement.

The Syrian War: The U.S. is putting together a significant assembly of military assets.  The U.K. and France have joined in.  Currently, there are four U.S. destroyers in the Mediterranean and two subs, with up to 400 Tomahawk cruise missiles available.  The U.S.S. Harry Truman will be in theater by late next week.  That adds an additional 300 Tomahawks and up to 90 aircraft.  B-2 bombers from Whiteman AFB in Knob Noster, MO are available.  There are over 100 aircraft at the U.S. facility in Qatar.  Britain is contributing 6 Typhoon fighter jets, two attack submarines and the H.M.S. Duncan, a destroyer.  France will also be contributing aircraft deployed from France.

This has the look of a broad and extensive military operation.  Syria is moving its military assets under the protection of Russian anti-aircraft and anti-missile systems.  President Trump has significant assets at his disposal.  Now we await what decisions are made.  In the run-up to a potential conflict, oil and gold prices have been rising.

Chinese data: As we note below, China’s credit growth, although up sequentially (mostly due to the New Year), is showing continued weakness on a yearly basis.  Total loan growth fell to 12.1% from 12.9% on a yearly basis.  China has a serious debt problem and Chairman Xi is trying to slow the growth of credit to arrest the problem.  However, slowing credit growth will certainly weaken the economy.  In the past, Chinese leaders have reversed course once it became apparent that growth was slowing.  Xi has amassed enough power to deal with slower growth; the real question is whether he will use that power.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It was a fairly quiet overnight session; the dollar reversed some of yesterday’s losses and equities are modestly higher.  This is what we are watching:

Ryan’s departure: Soon after last November’s elections, we framed the forthcoming political battle as “Ryan vs. Bannon.”  Now, both are gone.  Bannon was banished from the White House last summer and Speaker Ryan confirmed what had been rumored for some time that he isn’t going to run again.  Last November, our position was that President Trump wasn’t necessarily fully formed as a political figure and that the establishment (Ryan) and the populists (Bannon) were trying to get control of the president’s agenda.  Both figures are now gone because the president has established his political persona.  Trump isn’t as populist as Bannon had hoped—it’s important to remember that Bannon wanted to raise the highest marginal tax rate on households above 40% while cutting rates to lower income households.  Trump is too much within the establishment to sponsor that idea.  At the same time, trade policy, the growing fiscal deficits and Trump’s continued support for universal social spending (Social Security, Medicare) has made it clear to Ryan that his style of conservatism is no longer ascendant.  Thus, there is no reason for Ryan to remain as Speaker.

As we have noted before, our two-party system is really a form of forced coalitions and there are periods when the coalition groups within the parties are in flux.  This is one of those moments.  We don’t know for sure where all the various groups will eventually align but we strongly suspect that groups we currently think of as Republicans or Democrats won’t be the same in 10 years.

A walk back: Yesterday, President Trump caused quite a stir by suggesting an attack on Syria was imminent and warning Russia that missiles were coming.  This was something of a mistake; the military always prefers an element of surprise and tweeting about an incoming attack is counterproductive.  So, this morning, the president reintroduced an element of surprise by suggesting an attack may not happen at all (very unlikely) or will occur at some unknown date.  There are two things we are watching.  We expect an escalation from last year’s limited cruise missile strike which means (a) the U.S. needs more military assets in theater, and (b) the U.S. would prefer allies involved in this action.  The U.K. is considering joining the U.S. and we would expect France, which has long-standing ties to Syria, to also participate.  We would also anticipate at least some token participation by the Gulf Kingdoms.  On the first point, the U.S.S. Harry S. Truman has left port in Norfolk after extensive maintenance and training for the Fifth Fleet’s Area of Operations, which includes the Middle East.  Assuming it can reach the Mediterranean in 10-14 days, we suspect nothing major will happen before then.  Second, it will take some time to gather allies and coordinate a plan.  Thus, we still expect a military strike but not imminently.

A comment on equities: Whenever we have a period of equity market weakness, there are always concerns that equities are signaling economic weakness and a bear market is in the offing.  Our economic data indicator, which uses initial claims, commodity prices and consumer confidence, would suggest we are in a period of correction and consolidation but does not indicate an ensuing bear market.

The chart on the left shows the S&P 500 with our economic data indicator.  The indicator is constructed by normalizing the aforementioned economic data and creating an index.  The left chart shows the raw index; when it crosses zero, it indicates economic weakness and signals further weakness in equities.  However, it is somewhat “slow”; to correct this deficiency, we use the 18-month change in the indicator and the warning signal is when it crosses the red line, shown on the right chart.  This gives an earlier warning but avoids the false positives of a mere zero crossing.  As the charts indicate, there is no obvious danger coming from the high frequency data.

There are two caveats.  First, there is the usual “past performance doesn’t guarantee future performance” warning.  The second is that this is an economic model and should not be expected to signal warnings for geopolitical or political crises.

Energy recap: U.S. crude oil inventories rose 3.3 mb compared to market expectations of a 1.3 mb draw.

This chart shows current crude oil inventories, both over the long term and the last decade.  We have added the estimated level of lease stocks to maintain the consistency of the data.  As the chart shows, inventories remain historically high but have declined significantly since last March.  We would consider the overhang closed if stocks fall under 400 mb.

As the seasonal chart below shows, inventories are usually rising this time of year.  This week’s rise in stockpiles is normal.  Every week that fails to show a build on the seasonal pattern is a week where the seasonal factors become less bearish.  Although there is still time for stockpiles to rise, it will be virtually impossible for inventories to reach their seasonal norms.

Based on inventories alone, oil prices are undervalued with the fair value price of $64.54.  Meanwhile, the EUR/WTI model generates a fair value of $74.08.  Together (which is a more sound methodology), fair value is $70.92, meaning that current prices are below fair value.  Oil prices have been rising on geopolitical tensions but it should be noted that current inventory levels are supportive, as is the weak dollar.  If tensions remain high, the seasonal “flip” that will occur by early May will add to potential market strength.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s risk-off today; risk markets are lower on a swirl of issues that are weighing on sentiment.  Here is what we are watching:

Action on Syria: The president tweeted this morning, warning Syria and Russia that the U.S. is preparing an attack on Syria for its recent use of chemical weapons.  There are several known/unknowns with this action.  First, what will be the scope of the attack?  We see four potential outcomes.  It could be a mere symbolic attack like the one seen last year, where a salvo of cruise missiles hit various targets.  That event didn’t deter the Assad regime then and it won’t do so now.  The attack could also be broadened to strike chemical weapons dumps.  Such attacks do increase the risk of collateral damage, including triggering weapon spillage and inadvertent casualties of Iranian or Russian soldiers.  Third, the attacks could be broadened even further to include not just existing weapons but also production facilities.  This type of strike would increase the chances of collateral damage.  Lastly, the U.S. and its allies could directly attack Syrian military assets, including bases, aircraft, artillery, etc.  Collateral risks escalate with this option, but it would clearly get Assad’s attention.

The second “known/unknown” is the potential counter-response.  What will Russia or Iran do in response to a U.S. and allied attack?  Would Iran attack the Gulf States if they participate in airstrikes?  Would Iran target oil facilities?  Would we see a cyberattack in response?  Essentially, there are growing risks here, especially with a White House that contains more belligerent advisors than when a similar attack occurred last year.

We are looking for a broader attack and it may take a week to 10 days before the full event unfolds.  There are no aircraft carriers in theater at present.  Although there are significant U.S. military assets already in the region, if it is going to be an expanded attack we would expect at least one carrier group to be moved into position.  The CVN Theodore Roosevelt is in Singapore and could be in range within a week or so.  We also expect some participation from France, although it appears the U.K. has decided not to engage.  This event will offer insight into John Bolton’s influence; although regarded as an unabashed hawk, the role of the National Security Advisor is to offer the president options and advice.  The potential for escalation is elevated and may take some time to resolve.  Oil and gold are the greatest beneficiaries of this news.

Threats against Mueller: The media is rampant with reports that the White House is considering firing Special Counsel Mueller and it believes it has the legal authority to do so.  The consensus of legal opinion is that he doesn’t; only the Attorney General can do that and the current holder of that office has recused himself from the Russia investigation so the deputy has that role.  If the president doesn’t have the authority, we could see the spectacle of the “Saturday night massacre,” when Nixon ordered his AG Elliot Richardson to fire Archibald Cox.  Richardson refused so Nixon fired him.  Nixon then ordered Deputy AG Ruckelshaus to fire Cox; the deputy refused and was fired as well.  Nixon next ordered Solicitor General Bork to execute the firing, and a reluctant Bork did fire Cox (which probably prevented Bork from sitting on the Supreme Court).  Firing Mueller would get messy because it veers into the somewhat vague boundaries of constitutional power.  Usually, Congress sees such actions as interfering with its oversight of the executive branch and reacts.  As long as Congress is in the hands of the GOP, Trump might get away with removing Mueller.  However, Trump runs two risks.  First, Congress has historically reacted against the usurpation of its executive branch oversight and may turn on the president.  It’s important to note that most of the GOP leadership is establishment, not populist, and would not be overly opposed to quashing populism.  The establishment has gotten its tax cuts and may view the president’s actions as taking the party into areas where the elite would prefer to avoid.  Second, nothing would fire up the opposition more than removing Mueller.  The odds of the House flipping to the Democrats would be elevated (we note reports that Speaker Ryan is not seeking re-election), and removing Mueller would even put the Senate into play.  For markets, such turmoil would undermine sentiment; it would be negative for equities and probably bearish for the dollar as well.

Russian sanctions: Expanded sanctions on Russian figures close to President Putin have boosted aluminum prices as the Russian firm Rusal (486:HKG, HKD, 2.06) has been hit by sanctions.  U.S. regulators are warning British banks that their relations with Russian oligarchs could put them at risk.  The ruble is weakening and the small, but not zero, potential that Russian oil firms could come under scrutiny is probably helping oil prices this morning.

Facebook (FB, 165.04): CEO Zuckerberg generally held his own yesterday mostly because most of the questioners were completely ignorant of how not only social media works, but the internet in general.[1]  Only Ron Johnson (R-WI) nailed it when he asked Zuckerberg if his company should pay users for their data.  This is really the crux of the matter.  If social media is merely a constant focus group for advertisers, they should pay us for our time.  We don’t expect this train of thought to go anywhere.

Something of note: For the first time since the end of WWII, the Japanese Defense Force has created a contingent of marines.  The Japanese military has avoided such forces because they were seen as offensive units and its pacifist constitution outlawed such actions, therefore marines were seen as unnecessary.  Apparently, due to China’s growing threat and fears of likely U.S. disengagement, Japan has concluded it needs an amphibious force to protect its various island chains from encroachment.

Fed policy:  With the release of the CPI data we can update the Mankiw models.  The Mankiw rule models attempt to determine the neutral rate for fed funds, which is a rate that is neither accommodative nor stimulative.  Mankiw’s model is a variation of the Taylor Rule.  The latter measures the neutral rate using core CPI and the difference between GDP and potential GDP, which is an estimate of slack in the economy.  Potential GDP cannot be directly observed, only estimated.  To overcome this problem with potential GDP, Mankiw used the unemployment rate as a proxy for economic slack.  We have created four versions of the rule, one that follows the original construction by using the unemployment rate as a measure of slack, a second that uses the employment/population ratio, a third using involuntary part-time workers as a percentage of the total labor force and a fourth using yearly wage growth for non-supervisory workers.

Using the unemployment rate, the neutral rate is now 3.75%, up from 3.26%.  Using the employment/population ratio, the neutral rate is 1.68%, up from 1.25%.  Using involuntary part-time employment, the neutral rate is 3.22%, up from 2.58%.  Using wage growth for non-supervisory workers, the neutral rate is 1.67%, up from 1.28%.  The rise in core inflation, due in part to last year’s roll-off of mobile phone plan prices, has led to a significant upward lift in the Mankiw rule neutral rate estimates for all variations of the model.  If anything, this will increase the determination of the FOMC to continue on its path to hike rates.  We may get some insight from this afternoon’s minutes but, overall, it is reasonable to expect three more hikes this year.

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[1] It was a bit like Dave Letterman’s comments about having a “twitter machine.”  https://mashable.com/2009/12/09/david-letterman-tweet/#.LThK4_1UkqQ

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Risk-on is the order of the day.  Here’s what’s driving it:

Xi talks: Chairman Xi spoke at the Boao Forum yesterday evening and made promises to open China’s market to foreign investment and lower export impediments.  He indicated that auto tariffs will be lowered.  The tone was conciliatory and would offer the Trump administration a path to de-escalate trade tensions.  We have seen a steady escalation of tensions since January which has clearly spooked risk assets.  Trade tensions are a major element of those concerns (the FOMC is the other).  However, a word of caution is needed.  Xi was rather vague in his comments.  In fact, there isn’t much new here from his speech in Davos in 2017.  Xi’s goal appears to be two-fold.  First, he wants to lower the “temperature” on trade and offer President Trump a face-saving path to lower tensions.  Offering to lower car tariffs is a clear but minor concession that Trump could take to declare victory and smooth relations.  Since the Trump administration hasn’t really offered what it wants to accomplish with trade, he could declare the autos as sufficient.  There was a second element to Xi’s speech.  China’s view is that it wants to be considered a rival superpower to the U.S. and end America’s unipolar moment.  Thus, he wants to offer China as an alternative to the U.S. and is portraying China as the defender of free trade.  This is preposterous; China may be a rising superpower but it doesn’t engage in free trade at all.  Not only does it interfere with exports, but its financial system is mostly closed and therefore its currency can’t be used for reserve purposes.  If one runs a trade surplus with China and holds CNY as a result, it’s difficult to invest those CNY in the Chinese financial system in an asset like U.S. Treasuries.  So, the bottom line is that the speech was mostly fluff but the fact that he at least tried to lower trade tensions is being well received by financial markets.

The deficit: Yesterday, the CBO released its new deficit estimates, taking into account the tax reform act and the recent spending package.  The results:

Clearly, the deficit is going to rise.  Here is the key point—either the deficit is going to expand growth beyond capacity and lead to higher inflation, or it is going to lead to a wider trade deficit, or some combination of the two.  The deficit, all else held equal, will shift the aggregate demand curve outward from the origin.  The intersection with aggregate supply determines the level of output and the price level.  In a closed economy, this usually leads to higher levels of inflation and higher nominal interest rates.  But, in an open economy, the excess consumption usually leads to increased imports and a wider trade deficit.  The trade deficit outcome is dependent upon (a) global capacity—if it is insufficent then import prices will rise, leading to inflation, and (b) the exchange rate and the willingness of foreigners to hold the financial assets of the deficit nation.  For example, when Venezuela runs a fiscal deficit, no one will hold its bonds and the result is higher inflation.  The U.S., a the provider of the reserve currency, is uniquely able to run fiscal deficits and rely on foreign saving to partially fund it.  However, if American policy is determined to reduce the trade deficit while simulateously expanding fiscally, the result will be higher inflation.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] There is a whiff of “risk-on” this morning, with global equities higher while “risk-off” assets, such as gold and Treasuries, are lower.  Presidential tweets were relatively calm over the weekend.  Here is what we are watching this morning:

Social media to Capitol Hill: Facebook (FB, 157.20) CEO Mark Zuckerberg will testify later this week before Congress.  According to media reports, he is furiously preparing for the event.  The core issue facing the social media part of the tech industry is the public’s general lack of understanding of how these firms make their revenue.  There are no free services; if a service doesn’t include a charge, the firm is making money by collecting your data.  To some extent, this is how media has made money for a long time—newspapers sold advertising based on circulation.  Although they usually required a subscription, that was not the key source of revenue.  Social media has taken that model and expanded it by encouraging users to willingly offer up information about their behavior.  Previously, a firm advertising in a paper could know how many readers would receive their advert and maybe target a region for circulation.  By gathering information about you, social media can help advertisers target their segment (or, more to the point, “you”) directly.  An old line about advertising is, “50% of what I spend on advertising is wasted, but I can’t determine which 50%.”  Social media helps reduce the waste in advertising, so the more info the social media firm can gather about our behavior the more efficient advertising can become.[1]  Of course, the more social media knows about me the less privacy I have.  The debate society is now having is, “How much data-gathering is legitimate?”  Don’t expect social media firms to offer a reasonable response; it’s like asking a realtor if it’s a good time to buy a house.  This is where regulation will be required.  Regulation will tend to undermine the business model of social media but we won’t know to what degree until new rules are put into place.  But, in any case, the threat of regulation will tend to weigh on the tech sector.

Syria: Over the weekend, there were widespread reports that the Syrian government used a gas attack on civilians.  President Trump tweeted against the action and has, in the past, attacked Syrian military bases for using gas.  It appears Israel did launch missiles at a Syrian airbase.  Iran accused the West of fabricating the attack as a pretext to attack Assad.  President Trump has recently expressed the desire to pull U.S. troops out of the region.  It is probably no accident that Assad engaged in these horrendous acts after Trump’s comments.  The gas attack puts the U.S. in a difficult dilemma.  The Middle East has become uncontrollable.  Ever since the U.S. invasion of Iraq disrupted the balance of power in the region, Iran has been trying to expand its influence, Turkey has been countering against Kurdish statehood aspirations, IS rose and fell and Saudi Arabia has been trying to expand its influence as well.  Essentially, removing Saddam Hussein created a power vacuum and regional powers have been vying to fill the gap since.  The U.S. has been trying to extricate itself from the costs of being the balancing power in the region because (a) it is costly and distracting, and (b) we don’t need the oil anymore.  So, if Trump reacts by increasing American military presence in the Middle East, it means less resources to contain Russia in Europe and China in the Far East.  If the U.S. does nothing, we look weak, and Assad, Russia and Iran will try to expand their influence further.  With John Bolton taking over this week as national security advisor, we would not be surprised to see a rather robust response to Syria’s actions.

Lula turns himself in: Although former Brazilian President Lula resisted beginning his 12-year prison term for corruption, he has turned himself in, ending a potential source of civil unrest.  As we noted last week, the Brazilian Supreme Court’s decision to uphold his conviction throws open the presidency; there are no clear front-runners for October’s vote.

Orban wins: Although there was little doubt that PM Orban’s Fidesz party would prevail in this weekend’s elections in Hungary, the result was sweeping, bringing a two-thirds majority to the legislature.  Orban has been running on a nationalist and populist platform, opposing the EU and immigration.  European nations are turning toward populist and anti-EU parties (the recent Italian elections show a similar trend), and this is yet another election suggesting that populism is on the rise.

China talks CNY devaluation: Another part of the trade war threat came from China over the weekend as the country hinted it is “studying” the potential for devaluing the CNY.  We have been somewhat surprised that the administration hasn’t moved to weaken the dollar as a tool against the trade deficit.  China may be seeing this lack of currency commentary as an opening.  Although the CNY has been appreciating recently, China does control its currency and could decide to weaken it.  However, there is a danger for China, too.  History shows that fears of currency weakness seem to trigger capital flight out of China.  Chairman Xi may be confident that he has enough controls in place to prevent widespread capital flight, but money does tend to “find a way” under pressure.

North Korean denuclearization: Over the weekend, North Korea indicated it is open to discussing denuclearization with the U.S. in upcoming summit talks.  Although this assertion raises hope of a major deal, it also carries the risks that (a) Kim may be using this to lure President Trump into talks, and (b) the term “denuclearization” is fraught with strategic ambiguity.  Regarding point (a), just getting the meeting is a boost for North Korea.  Previous presidents have been reluctant to talk directly, using that as the ultimate “carrot” for Pyongyang.  So, even if the talks don’t bring about any major developments, the photo-ops of the two leaders together will improve Kim’s stature.  Concerning point (b), denuclearization for Kim probably means that he allows inspectors if all U.S. troops leave South Korea and North Korea is no longer a target for regime change.  For the U.S., the term means that North Korea gives up its nukes.  Both leaders can agree on denuclearization and come away with completely different positions.  A reasonable expectation?  North Korea keeps its nukes but gives up long-range missiles, which would reassure the U.S. but terrify Japan, South Korea and China.

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[1] An old, but famous, incident of data-gathering and advertising was documented here:  https://www.nytimes.com/2012/02/19/magazine/shopping-habits.html?_r=1&hp=&pagewanted=all

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equities rebounded strongly yesterday after an opening sell-off.  So far, U.S. stocks are building on yesterday’s gains.  Here is what we are watching this morning:

As a point of reference: We have a weekly chart on the S&P 500 P/E ratio at the end of this report.  The methodology of our calculation is explained in the footnote but, essentially, we try to create a multiple that avoids the pure backward-looking problems of a trailing P/E and the worst of the “fantasy” of a pure forward-earning estimate.  With the onset of Q2, the P/E has dropped 2x.  The combination of strong earnings and the recent price correction has reduced some of the valuation concerns.  Continued economic growth and the impact of the tax bill on earnings should support continued robust earnings growth.

The key worry remains inflation.  Inflation volatility does affect the P/E.

This is a near replica of the chart at the end of this report but we have added two periods with gray bars and created averages and standard deviation lines for these periods.  The lower line on the chart shows the five-year rolling standard deviation of CPI.  During periods of low inflation volatility, the multiple tends to expand.  Based on the assumption that inflation volatility will remain less than 2% (what we see in the gray areas), the current multiple isn’t excessive.

This is partly why the trade turmoil is causing such market volatility.  Since the 1980s, the trade deficit has clearly dampened inflation.  This is the impact of globalization.  Backing away from free trade carries the potential to boost price levels and raise inflation volatility.  The real concern is if inflation volatility rises to levels seen outside the gray areas on the above chart; a reset of the P/E would be expected to follow.  In periods with higher inflation volatility, the P/E averages 13.1x.  In periods of low volatility, it averages 17.7x.  The reset creates extended bear market conditions.  So far, we remain in the gray band, which is favorable for equities.  Nevertheless, trade war worries are legitimate and inflation volatility is the key metric.

Lula looks finished: Former Brazilian President Lula had been a candidate for a return to office.  However, the Brazilian Supreme Court has ruled that the former president should face jail time for his corruption conviction.  Lula was involved in the widespread “Lava Jato”[1] scandal and convicted of receiving bribes.  Lula maintains his innocence; apparently, the Supreme Court disagrees.  With this decision, the October presidential election is up for grabs.  Polling showed Lula as the most popular candidate but this ruling likely ends any chances he will be eligible to run.  Thus, the potential for political and market volatility will increase as the elections approach.

A new Plaza?  The 1985 Plaza Accord led to a massive downtrend in an overvalued dollar in a bid to bring down the trade deficit.  So far, the Trump administration has mostly avoided currency manipulation as a threat or tool in trade negotiations.  However, that strategy may change.  In the next few weeks, the Treasury is expected to produce its semi-annual update on exchange rates.  The report determines whether an exchange rate is being manipulated in such a way as to build a trade advantage.  In practice, this report usually perpetuates the fiction that no nation is engaging in such currency policies, although, like gambling at Rick’s American Café, everyone knows it’s going on.  There is growing speculation that the president will discover the power of forex pressure.  The recent new trade deal with South Korea included a side agreement to end the country’s rather blatant currency manipulation.  We would not be shocked to see the administration begin talking down the dollar.  We bolded the word “mostly” above because Treasury Secretary Mnuchin noted at Davos that a weaker dollar would aid in lowering the trade deficit.  The president recoiled at the term “weak dollar” but if he can be schooled on the idea that a weaker dollar is good for trade then it would make sense to use exchange policy to achieve this aim.  The market outcome would be to further support foreign investing for dollar-based investors.  It should also help precious metals.

Energy recap: U.S. crude oil inventories fell 4.6 mb compared to market expectations of a 2.0 mb build.

This chart shows current crude oil inventories, both over the long term and the last decade.  We have added the estimated level of lease stocks to maintain the consistency of the data.  As the chart shows, inventories remain historically high but have declined significantly since last March.  We would consider the overhang closed if stocks fall under 400 mb.

As the seasonal chart below shows, inventories are usually rising this time of year.  This week’s decline in stockpiles was unusual and is bullish for prices.  Every week that fails to show a build on the seasonal pattern is a week in which the seasonal factors become less bearish.  While there is still time for stockpiles to rise, it is unlikely they will reach their seasonal norms.

Based on inventories alone, oil prices are undervalued with the fair value price of $65.74.  Meanwhile, the EUR/WTI model generates a fair value of $74.94.  Together (which is a more sound methodology), fair value is $71.98, meaning that current prices are below fair value.  Oil prices remain range-bound but should move higher by early summer when the driving season begins.

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[1] Car Wash