The Daily Prophet: Oil Is Complicating Lots of Popular Trades

Connecting the dots in global markets.

The roller coaster that is otherwise known as the oil market is heading lower -- again -- and dragging down almost everything associated with the energy complex. Wednesday’s weakness was based on a familiar theme: doubts that prolonged cuts by OPEC and its allies will succeed in clearing a surplus while U.S. output remains so resilient.

Even though Saudi Arabia’s Energy Minister Khalid Al-Falih said the cuts are working and predicted global inventories will fall to the five-year average in early 2018, American drillers continue to add rigs to shale fields, according to Bloomberg News’ Meenal Vamburkar. “There doesn’t seem to be an end to supply out there,” said Bob Yawger, director of the futures division at Mizuho Securities USA. “And demand is not exactly rip-roaring.” American drillers last week boosted the number of active rigs to 722, the most since April 2015, according to data from Baker Hughes. 

To the strategists at JPMorgan, the gyrations in the price have wide implications. The broad range of $40 to $60 a barrel that the market is stuck in is depressed enough in terms of average prices and wide enough “to complicate” a number of key trades that investors have piled into that are dependent on faster inflation. Those include shorting bonds, owning debt securities that protect against rising consumer prices, and betting on the currencies of some commodity-dependent economies over the next year. Energy stocks are the worst-performing sector in the MSCI All-Country World Index this year, falling 8.39 percent on average.

Despite a seventh straight month of gains for the global stock market, May ended with a bit of a whimper. Equities fell as financial stocks faltered on news from JPMorgan and Bank of America, the two biggest U.S. banks, that second-quarter trading revenue is on pace to drop at least 10 percent because tranquil markets are curbing demand, according to Bloomberg News’ Hugh Son and Dakin Campbell. Even before the latest revelations, financial shares were under pressure as a rally in longer-term bonds caused the difference between short- and long-term borrowing cost to shrink, raising concern about the health of banks’ net interest margins. One proxy of financial shares, the PowerShares KBW Bank Portfolio exchange-traded fund, dropped 2.80 in May, bringing its loss since the end of February to 7.40 percent. Financial shares had soared in the prior four months, leading markets higher on the prospect that the Trump administration would loosen restrictive bank regulations. The PowerShares KBW Bank Portfolio ETF soared 29 percent between the end of October and the end of February.

In fact, most of the Trump administration’s pro-growth policies are in doubt, from tax reform to infrastructure spending -- at least for this year. Pacific Investment Management Co. was out with a report Wednesday saying that investors have become too complacent and that monetary, fiscal, trade and geopolitical risks abound. As they see it, there’s a 70 percent chance of a recession in the next five years, according to Bloomberg News’ John Gittelsohn. “We believe that many market participants today are too relaxed, that medium-term risks are building and that investors should consider using cyclical rallies to build cash to deploy when markets eventually correct -- and possibly overshoot -- as risks are repriced,” the firm said in its annual “Secular Outlook” for the next three to five years. Of concern to Pimco is that policy makers are “driving without a spare tire” because of limited tools -- caused by big balance sheets and low or negative interest rates -- to deal with a recession.

Given the worrying over at Pimco, perhaps it’s not surprising that hedge funds are jumping back into gold at the fastest pace since 2007. Money managers boosted their long positions in U.S. futures by the most in almost a decade in the week ended May 23, Commodity Futures Trading Commission data show. Bullion futures have posted three straight weekly gains, helped by U.S. and European political angst that has boosted demand for the metal as a haven, according to Bloomberg News’ Joe Richter. Those bets have paid off with gold advancing Wednesday to its highest since April 25, or $1,276.80 per ounce. According to strategists at BMO Capital Markets, the Federal Reserve’s monthly Beige Book economic report struck a dovish tone on the economy, offered a divergence from the “all is well" mantra as optimism waned in some districts, namely Boston, Chicago and New York. Is it too late to buy some gold?

Foreign-exchange traders and strategists alike are (re)learning a tough lesson: Don’t bet against the yuan. The currency has jumped to its highest level in seven months offshore, soaring as much as 1.1 percent on Wednesday alone, despite analyst forecasts for declines this quarter. Surging interbank rates are squeezing bears by driving up the cost of short positions, according to Bloomberg News’ Helen Sun, Molly Wei and Emma Dai. The rally, which broke months of calm against the dollar, came on the heels of an unwelcome credit-rating downgrade from Moody’s. China made its displeasure clear, calling the move “absolutely groundless.” The central bank had already been battling pessimistic traders by repeatedly strengthening the daily fixing. “The Moody’s downgrade and a weaker spot rate compared to the fixing could have spurred the authorities to change the fixing mechanism and potentially intervene in the market,” said Jason Daw, Singapore-based head of emerging-market currency strategy at Societe Generale.

The stock markets of the world’s developing economies are about to undergo a bit of a revolution. As the index provider MSCI prepares to carry out its annual review in June, some of the world’s biggest markets -- with assets totaling almost $9 trillion -- are poised for reclassification, according to Bloomberg News’ Srinivasan Sivabalan. Perhaps the most notable are China and Saudi Arabia. China’s domestic equities were denied entry into MSCI’s benchmark indexes for a third year last June despite measures to address such concerns as repatriation limits and excessive trading suspensions. Only 169 mainland-listed companies will be considered for inclusion, down from 448 under a previous proposal, and all will be large-cap shares currently accessible to foreign investors through exchange links with Hong Kong. Two years after Saudi Arabia opened its stock market to global investors, foreign ownership has languished at about 5 percent and the equity index has lost about 30 percent. The market’s size fell by about $140 billion as the changes coincided with the government’s austerity measures. The country says its bourse has met all the criteria laid out by MSCI for inclusion.

After Wednesday’s rather downbeat Beige Book, the monthly manufacturing report from the Institute for Supply Management will surely get extra attention. The median estimate of economists surveyed by Bloomberg News is for a reading of 54.6 for May, little changed from 54.8 in April. Recall that the weaker-than-expected result in April left the index essentially back at December’s levels that, according to the economists at Bloomberg Intelligence, may have been due to less optimism among manufacturers in the Trump administration’s capacity to deliver on a pro-manufacturing policy agenda. The BI economists say they will be paying attention to export orders, with any signs of resilience signaling a firming in external demand, which could provide a modest tailwind to growth.

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