Market Insights – May 14th, 2018

Last week, investors awaited April inflation figures for the USA with bated breath. The previous week, they learned that US wages had risen only slightly. Yet investors remain on the lookout for any signs of a change in the price trend across the pond. Like the two companions in Samuel Beckett’s famous play Waiting for Godot, most economists have waited month after month for the uptick in prices to finally materialise in the USA. And like Godot, inflation seems to want to keep the myriad of observers on tenterhooks about its potential (re)appearance. Inflation is most definitely on an uptrend, but it is a very gradual one. In April, the consumer price index did not rise as much as expected, and year-on-year core inflation (i.e. excluding more volatile elements) levelled off at 2.1%. The Federal Reserve will nevertheless be relieved to confirm that its 2% target has been reached. That will give it the justification it needs to raise rates further going forward. The Fed may also want to build a safety cushion into its key rates for the day when the economy starts to slow. This could, for instance, happen in 2020 with the fallout from the end of the US tax cuts. Elsewhere in the world, other central banks don’t have the same luxury because growth and inflation are not strong enough to justify any rate hikes for the time being. This is the case for the European Central Bank and the Bank of Japan. And some central banks that looked to be about to raise rates have since quashed these hopes – the Reserve Bank of New Zealand, for instance, announced that it would keep interest rates low until its 2% inflation target is achieved. We think the lack of inflation is a good thing, particularly for the USA. There’s no need to bring this ageing business cycle to an end by aggressively tightening monetary policy. This will allow the virtuous circle of steady, non-inflationary growth to continue. Unless upcoming inflation data have some major surprise in store, this Goldilocks scenario should remain in place over the short term. This should boost risk assets – and particularly stocks.

The USA’s announcement that it intends to scrap the 2015 nuclear deal and re-impose sanctions on Iran put pressure on oil prices. Opec members and US producers will of course try to make up for the shortfall caused by this new embargo. But some importing countries will find it hard to quickly fill the gap.

At first glance, it looks like the Chinese, South Korean and Japanese petrochemical industries will be hit hardest by the decision, and requests for exemptions could soon land on the US president’s desk, which is what happened with the last embargo.

What’s more, the crisis in Venezuela has seen that country’s oil output plummet by more than 40% since 2015. Some observers think that it could still contract by a further 0.5 to 1 million barrels a day before the end of the year!

And to top it all off, US sanctions against Russia have – albeit indirectly – affected that country’s oil industry. On the demand side, global economic fundamentals remain buoyant, and demand for energy should stay high, thanks in particular to infrastructure projects in the USA and Asia.

If the current climate remains unchanged, the outlook appears bright for oil. This should, for example, boost US oil exports.