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Episode 9: Qasem Soleimani’s death, US Payrolls and UK construction

Episode 9 - Part 1

How Qasem Soleimani’s death has affected oil prices

Published on: January 7th, 2020 • Duration: 8 minutes

In this episode, we first examine the non-manufacturing ISM data to see if it will drop like the manufacturing ISM data has and what the implications of the new numbers will provide. Then, we discuss the price action that oil has experienced in the last few days in light of Qasem Soleimani’s death from the drone strike ordered by President Trump and how investors should position themselves going forward.

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08:11
  • This is Before & After from Refinitiv. 

    I'm your host. Johanna Botta. In our first episode for 2020, we're going to take a look at the non-manufacturing ISM data to see if they can continue to hold up despite yet another drop in the ISM manufacturing data. 

    Then we're going to take a look at U.S. oil inventories, because the U.S. hit on General Soleimani has brought the energy complex right back to the center of market concerns. 

    The U.S. non- manufacturing ISM will be released early this week, and will be a good indication of whether the new decade will continue to see the resilience in the services sector that supported markets during 2019. In the last reading, the November non- manufacturing ISM came in below forecasts, with a fifty three point nine reading versus a fifty four point five estimate. The reading was, however, dragged down by a steep decline in the business activity component. This number came in at fifty one point six versus fifty seven the prior month, a complete collapse, and the lowest reading since January 2010. 

    Will the positive developments in trade negotiations in December, paired with a strong holiday season and markets making new highs through last month, improve sentiment? And will the non-manufacturing figure continue its divergence from the manufacturing data, which last week made new lows, its fifth consecutive reading in contraction territory?

    Agriculture, wholesale trade and construction stood out in last month's report as weak industries. That's not too surprising. As we know, trade and farming have seen very real ramifications from the trade wars with China. But one would expect construction to perk up considering the doveish borrowing environment. And of course, strength was seen in the tight job market reading, which has continued to defy many people's expectations of a slowdown. 

    Each year, has its own identity in the markets. Themes and regimes become established early and can set the stage for how market observers need to adjust their strategies. With a much higher bar for further accommodation from the Fed in 2020 than in 2019, economic data points need to be that much more extreme to move the needle. We're going to want to see a rebound in the business sentiment activities reading this month. Another steep decline could indicate that the cuts of 20 19 were not enough, but with stocks already a bit stretched after the year-end rally, plus the additional geopolitical risks, which we will come to later, it's a 50/50 ball on stocks rallying on dovish numbers. 

    So we should be watching U.S. Treasury yields on big numbers. Last week the U.S. 2 year, 10 year part of the yield curve steepened to its widest levels since October 2018. In fact, it's been a bear steepener where longer term yields rise faster than shorter term yields, indicating that investors are either reevaluating growth to the upside, or maybe are concerned about inflation and the risks of ballooning debt. 

    With that in mind, we should focus on U.S. 10 year yields. Should they rise on the back of a stronger ISM non-manufacturing number? Consensus is fifty four point five. If a beat occurs, coupled with signs that commodities are breaking out, then we should expect longer term yields to reverse at the recent geopolitical weakness, and the U.S., 10 year yields start to head back toward the key psychological 2 percent level. In light of the recent flare ups of tension in the Middle East, we feel that oil prices will be a key driver of the narrative in world markets. And we'll look at inventory supplies this week as well as price action oil to map out what to expect next. 

    On Friday of last week, President Trump ordered a drone strike that killed a top Iranian general, Qasem Soleimani. This was an unexpected action that could have serious recourse and saw an almost instant four percent spike in the price of oil. This comes at a time where OPEC has already made a concerted effort to cut oil production and mitigate the global oil glut that has kept energy prices relatively subdued for most of 2019. 

    But first, some history. On September 14, 2019, drones were used to attack the state owned Saudi Aramco oil processing facilities at Abqaiq. This attack took half of Saudi's oil production, five point seven million barrels a day off line - 5 percent of the world's total. While no responsibility has been assigned for the attacks, Iran was widely suspected to have been involved. Now why does it matter? Clearly, a sustained tension or worse, a war with Iran would impact oil supplies coming through the Strait of Hormuz. 

    Now, what is the Strait of Hormuz? It's a narrow passage from the Persian Gulf. And according to the EIA, it's the world's most important energy choke point. On average, about 22.5 million barrels of oil a day pass through the strait. That is roughly 24 percent of daily global oil production over that period. That's nearly 30 percent of oil moving over the world's oceans. Roughly 80 percent of the crude it handles is destined for Asia. The global economy could not function without those supplies. Last week, when the strike occurred, Brent Crude, the international proxy, rallied to its highest price since, you guessed it, September 14th, and those attacks on Saudi Arabia. 

    You can clearly see the price spike in September, but it almost as quickly faded. Seeing Brent collapse ten dollars within a few days. Will this time be different? Is this the price spike that holds this week's inventory? Number and reaction will provide a pointer. We saw a sharp drop last week of 11.5 million barrels of crude, when expectations were for a 3.3 million barrel drop. When the attack in September happened the price of oil quickly reversed. However, inventories were still rising at that point. Another big drop in supplies coupled with simmering tensions, should see Brent break out and challenge the 75 level in rapid fashion. Another key data point to watch is West Texas / Brent oil spread. Basically the U.S. versus the rest of the world. 

    Brent Oil is the contract that has a bigger Saudi oil premium priced in and will drive the entire energy complex higher in times of real crisis. This spread should blow out because a U.S. market is now a net exporter and less reliant on overseas supply. A ten dollar spread of Brent over WTI would be a stretched level. If you're looking to fade this news, then do so in instruments unrelated to oil such as the Japanese yen and gold, which both strengthened on the news. In fact, the gold has just made a new six year high. There is much less risk, though, also less reward, in fading the broader market moves. 

    There it is. U.S. non-manufacturing, ISM and U.S. crude oil inventories. Refinitiv Data throughout.  

    This has been the Tuesday episode of Before and After. Please be sure to like, subscribe and hit the notification bell.  Share us with your friends, and we'll be back on Friday. 

Episode 9 - Part 2

US Payrolls & UK Construction—On a Positive Roll?

Published on: January 10th, 2020 • Duration: 7 minutes

In this episode, we dive in on US manufacturing payroll numbers, speculating on the effects of the recent, positive US jobs reports. Then, we discuss the investor sentiment following the UK elections and how that will affect the construction sector. Finally, we will review the ISM non-manufacturing reports and how the new numbers effected bond yields.

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07:12
  • This is before and after from Refinitiv. I'm your host. Johanna Botta. 

    The talk of the markets last month was a monster beat in U.S. payroll numbers. Will that trend continue? The reaction of markets could provide a huge clue for asset price returns in early 2020. 

    The U.S. jobs market was perhaps the single most consistently strong economic indicator in the developed world last year. And everything from interest rates to the presidential election, could depend on the performance of that jobs market. 

    After the end of the General Motors strike had bumped up the November reading, a more tepid payroll number is expected for December. Now, it's also important to note that even before the U.S./ China trade truce was announced last month, we had already begun to see a rebound in the struggling manufacturing sector. Now, in October, the manufacturing payroll number fell 43,000. But in November, the sector added 54,000 new jobs. And overall, last month, the report for November jobs was a massive upside surprise. 

    Now, non-farm payrolls data showed that the U.S. economy added 266,000 jobs versus an estimate of 180,000. This is consistent with a not too hot, not too cold growth rate that the market currently prefers. The market has become very accustomed to a strong jobs number, so we could see a diminishing effect on global risk assets if the number once again outperforms expectations. 

    This month we need to pay extra close attention to the average hourly earnings figure because inflation expectations could start to pick up if there are clear signs of wage growth. 

    Gold is one potential asset price reaction to watch out for this week. Many people consider it a great inflation play, although it's been tracking yields, especially real yields for much of the last 10 years. Last month's stellar jobs report saw gold sell off more than 1 percent. But, over the last few days, geopolitics has given the precious metal a little bit of momentum. 

    The latest gold bull move could be linked to the fallout from the U.S. military strike. Now, if we look closer, the expanded balance sheets of central banks could also be a cause of the recent surge in gold prices. Gold has been following the path of inflation linked securities such as the U.S. Treasury 5 to 10 year tips. When bonds rise and both nominal and real yields fall, and FYI real yields are inflation adjusted yields, then gold rises and vice-versa. So if we get another strong payrolls print, then U.S. bonds could sell off, pushing nominal and real yields higher. That could allow gold to pull back farther from its recent highs, which would provide the sort of pullback that a gold bull would want to utilize to initiate or add to a position. 

    On the heels of a landslide victory by the Conservatives in last month's British elections, it feels like a bit more stability and certainty is now seeping into the market there. 

    This week, we'll take a look at U.K. construction data. And although this is a November figure taken from before the election, the market reaction will offer us a great glimpse at real investor appetite in the UK.

     The October number was very weak, as it declined 2.3% month over month, much weaker than the anticipated fall of 0.2%. And the November reading out this week is expected to bounce back, with a 0.6% month on month increase. The election should prove to be a turning point for sentiment. 

    Remember, this is a pre-election number, so if there are any market weaknesses on a bad print, then we want to use that as a buying opportunity. 

    And the jump in shares of the UK homebuilder Taylor Wimpy, shows you just how enthusiastically investors had bid up the residential sector after the Conservative victory was confirmed. The stock jumped from one seventy four to one ninety nine on the day after the election. That's an 8% rise in a single day on huge volume. You kind of have to have respect for that sort of upside volume when there is a constructive trend in place. This stock and the sector have probably gotten ahead of the real fundamental picture for UK residential construction. Another horrific reading on the construction number should offer a short-lived opportunity on the downside. Expect the buyers who bought 100 million shares on December 13th, that's the day after the UK election, to re-emerge on any real pullback of more than 5 percent. 

    But a big sell off on a strong reading, which would show the economy is already starting to match expectations, would indicate that the sector could be in for a bit of a longer pass. 

    The non-manufacturing ISM number came in stronger than expected at fifty five versus a forecast of fifty four point five. This was the strongest number in four months and the business activity gage, that we highlighted in the last episode, had a very strong rebound of seven points to fifty seven point two. A bounce up from the 10 year low registered last month. And what did U.S. treasuries do? At first blush, though, not a lot, the 10 year yields consolidated above the one point eight one level and the two year, 10 year yield curve, which had already come off 10 bips from a multi month high, settled around 26 basis point level. For now, it looks like the geopolitical headlines are trumping the economic data in defining the very short term direction of asset prices. 

    There it is. U.S. payroll, U.K. construction and U.S. ISM non-manufacturing. Refinitiv data throughout. This has been the Friday episode of Before and After. 

    And, as you can see, this is a massively important time. If you want to be alerted to the very latest market moves, first, subscribe below and then hit that notification bell. We'll see you on Tuesday.