Daily Comment (May 13, 2016)
by Bill O’Grady and Kaisa Stucke
[Posted: 9:30 AM EDT] As noted below, there was an interesting divergence between Q1 Eurozone GDP growth and German GDP growth. The former was revised lower to 0.5% (2.0% annualized for the quarter), while German GDP was revised higher to 0.7% (2.8%) from 0.6% (2.4%). Spain also grew strongly, up 0.8% (3.2%). France (0.5%; 2.0%) and Italy (0.3%; 0.9%) were the laggards. The pickup in German growth is particularly good news for the Eurozone economy. Germany’s strong saving has led to large trade surpluses that have been offset by trade deficits in the rest of the Eurozone (at least with regard to internal Eurozone trade). Rising German growth means that the rest of the Eurozone can export goods and services to Germany, which will tend to boost their economies and relieve some of the debt problems in the region.
The Obama administration announced another set of regulations on the fracking industry designed to reduce the amount of methane that escapes into the atmosphere during the drilling process. These new regulations will undoubtedly raise the costs of drilling. The government and industry dispute the actual amount, with the EPA arguing it will cost the industry $530 mm into 2025; the API suggests this number probably should be doubled. In any case, the real takeaway is that the regulatory process usually works with a lag. A new technology or process often can work without little regulatory oversight because the government hasn’t seen it long enough to determine whether it should face regulation and how it should be done. However, the longer the new process is in place and the bigger it gets, the more likely it is to face regulatory scrutiny. For the pioneers in the industry, the influx of regulation is jarring because they were able to initially operate with little interference. The bottom line: the U.S. oil and gas industry will be facing increasing regulatory costs regardless of who wins in November. This development may not be bullish for oil and gas companies but it is undoubtedly bullish for the price of the commodity—regulation will act to constrain supply.
The better than forecast retail sales data (see below) has led to a flattening of the yield curve.
The spread is approaching the lows set in late February. The flattening of the curve is a form of monetary tightening and is bearish for equities.