Daily Comment (April 22, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Easter Monday! Most of Europe is closed today, along with a few Asian markets (Australia, New Zealand). It’s also Earth Day. There was a horrific terror event Easter Sunday against Christians in Sri Lanka.[1] Here is what we are watching:

Oil: The Trump administration is signaling that there will be no more import waivers granted on Iranian oil.[2] This decision was something of a surprise. Although SoS Pompeo and National Security Director Bolton supported this hardline stance, the president was reluctant to take this step for fear of higher oil prices.[3] In response, oil prices have jumped on the news. In other Iranian news, the Supreme Leader Khamenei announced the replacement of the commander of the Iranian Republican Guard Corps (IRCG). Gen. Hossein Salami was elevated to the post, while Gen. Mohammad Ali Jafari was removed.[4] Salami is considered a hardliner (in a rather hardline group), so this move does suggest Iran is preparing for a more hostile environment.

Iran is the proximate cause for today’s lift but we have noted that overall geopolitical risk is adding around $10 to $12 per barrel to the price of oil; the current price is well above what the dollar and oil inventories would suggest. In Libya, the Trump administration shifted course with regard to political leadership, offering a full endorsement of Khalifa Hifter.[5] Hifter, a former Libyan general under Khaddaffi who broke with the late Libyan leader, offers a secular leadership option for the country. It isn’t clear if the endorsement will lead to overt support, such as equipment and funding. So far, Hifter has been less than impressive on the battlefield.[6] If the conflict escalates, the potential for further supply disruption is high.

Venezuela remains problematic. Electricity outages, trade restrictions and sanctions continue to weigh on production. There are reports that the Russians are helping Caracas evade sanctions.[7] Although this action might support an increase in Venezuelan supplies, we doubt the U.S. will allow this evasion to continue indefinitely.

Although we remain bullish on oil prices, we are at the point where the primary bullish factor is geopolitical. We are probably approaching a crux where it will be difficult for prices to sustain these levels without either (a) a continued flow of news that signals further supply disruptions, or (b) improving fundamentals (falling inventories or dollar weakness).

A funny guy wins in Ukraine: The voters in Ukraine have spoken with a landslide victory[8] for Volodymyr Zelensky, defeating incumbent president Petro Poroshenko. Zelensky has no political experience—in fact, he played a political leader on a Ukrainian TV show.[9] Zelensky is a comedian by trade and his victory is another indication of the anti-incumbent mood of electorates and the desire for something “different” across the West. It is unclear how well Zelensky will govern a difficult nation in an unsettled geopolitical environment, but voters in Ukraine were apparently willing to take the chance.

China: Reports that Chinese leaders are more focused on reform and less on boosting growth led to a slump in Chinese equities today.[10] According to reports, in a review of the Q1 economy, the 25-member Politburo congratulated themselves for navigating the trade conflict with the U.S. and signaled that Chinese policy will continue to focus on reform and show less concern toward excessive growth.[11] The need for economic restructuring is nothing new; China is in the midst of the difficult shift from investment-led growth to consumer-led growth. When the U.S. went through this process, we suffered the Great Depression. Japan is still struggling to make this adjustment which began in 1990 and has led to nearly three decades of stagnation. In practice, Chinese leaders have tended to start the process of reform, which will lead to slower growth and falling debt, but upon seeing weaker growth the leadership has panicked and boosted spending and debt. Chinese financial markets have enjoyed a rally on expectations that Chinese leaders have “blinked” again in the face of slowing growth. Today’s news suggests that reform remains on the agenda; our position is that the CPC is not confident enough to allow growth to decline and thus the continued pattern of “reform, panic, stimulus, reform” will continue. But, we do acknowledge that there will be a point when China’s debt capacity will be reached and it will be impossible for them to continue this process. We don’t think we are close yet, but the signal that the endgame is approaching will be when China taps foreign capital markets for loans. That has started but isn’t at a huge level…yet.

The dollar: In a survey of conference calls on Q1 earnings, the largest area of company concern is dollar strength, with the second being increasing labor costs.[12] So far, the Treasury has maintained a strong dollar policy, not supporting steps to weaken the dollar. At some point, we do expect a reversal of this policy and industry opposition to dollar strength could be a factor that brings about this policy shift.

View the complete PDF