Daily Comment (March 23, 2016)

by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] In the aftermath of the terrorist bombings in Belgium, security officials in Europe have been working feverishly to track down the identities of the bombers and search for other terrorist cells.  It is widely thought that this cell was already in place and may have decided to activate after the recent arrests of other suspects.

A couple of observations are in order.  First, it appears that financial markets are becoming increasingly inured to terrorist events.  The reaction in equities was quite modest and the rally in gold is partially reversing today.  Second, attacking Brussels, the seat of the EU, looks like a big deal.  However, true sovereignty rests at the national level, not at the continental level.  The EU has no military.  It has a continental investigation unit but it cannot issue arrest warrants.  IS won’t face calls for military intervention like those that followed the Paris bombings.  The reason is that France has a military; the EU does not.  Thus, the attacks in Brussels are more symbolic than the Paris attacks but probably won’t lead to stepped up attacks on IS.

Is Yellen facing a rebellion?  The last FOMC meeting was decidedly dovish but three presidents, Dallas FRB President Harker, San Francisco FRB President Williams and Atlanta FRB President Lockhart, all made statements this week suggesting that they disagree with the pause in rate hikes and want the Fed to start raising rates.  It should be noted that none of these presidents are voting this year.  Thus, their statements, though important, don’t necessarily mean that policy is going to reverse.  However, it does suggest that Yellen may be facing more opposition to a dovish stance.  At the last meeting, KC Fed President George dissented.  At the time of this writing, St. Louis FRB President Bullard is talking on Bloomberg and is leaning toward tightening, although he seems quite comfortable with an inflation overshoot.  Bullard is a voter and he said he wants to see April as a “live meeting,” but the real thrust of his comment is that he thinks the Fed is giving out too much information and should stop offering “balance of risk” statements and dump the “dots” chart.  We agree this is exactly what the Fed should do.  The real issue is that the markets have adjusted to a dovish central bank and these statements suggest that the robustness of this dovish stance may be rather low.

Oil prices have enjoyed a nice lift (we get the DOE data later this morning), but the IEA is on the tape today suggesting that the OPEC freeze may be “meaningless” because Saudi Arabia is the only nation that can boost production anyway.  It is our position that this rally was a correction from oversold levels that were caused by uncertainty surrounding the availability of storage.  It appears that the industry has managed to find space for inventory and this, along with a drop in the dollar (partly caused by the unexpectedly easy Fed, noted above), has led to a strong rally in oil prices.  We believe this rally has eliminated the oversold rally and more, and a modest correction (prices between $30 and $35 per barrel) is likely in the coming weeks.  We think the recent lows will likely be the lows for this cycle but we don’t expect a major recovery unless the Saudis change their oil production policy.  In other words, without a cut in Saudi production, the oil price recovery will be “L” shaped, like what we saw after the oil market stabilized in 1986.

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