A Bearish Perspective
Welcome to the fourth blog entry of the Weekly Overview Series.
In this week…
- Trump warns of pain ahead. He updates his total death estimates from 100,000 to 240,000. Pessimistic predictions say the daily deaths’ rate peak could be at more than 3,000 while optimistic lower this down to 1,000.
- Crude Oil suffers again with a potential incursion in the under $20s territory as the OPEC fails to agree on an emergency meeting, the price war deepens, and US oil inventories pile up. Trump aspirational tweet of a 10 million barrels cut globally leads to a 25% sharp spike in the oil market on Thursday.
- US Congress is preparing a new $600 billion stimulus package focused on aiding the mortgage market and the travel industry
- JPMorgan Asset Management says it is too early to buy stocks right now.
In this blog entry, first I want to talk about the Eurobonds turmoil and possible European solutions to stimulate the economy. As with the dollar swap lines and credit markets, not just Eurobonds but also the further solutions are not in the headlines but are essential to analyse the current economic situation.
Eurobonds and other possibilities: the ESM
Maybe an unrealistic dream for some European countries, Eurobonds were first put on the table by the Italian Prime Minister Giuseppe Conte. The euro region shares the monetary policy, but it is far from agreeing on fiscal policy. There are hawkish countries such as Germany and the Netherlands (they tight their government spending to have a surplus) and Greece, Italy, France or Spain that are dovish (they are less strict on government spending and they usually have government deficits).
Eurobonds are conceived as a joint debt issuance by the eurozone. They are being discussed as, once again, fiscal dovish countries are realising how their government bonds yields are spiking due to investors fearing an increasing risk of credit default. Big additional fiscal stimulus packages have been approved to respond to the Coronavirus emergency and the deficit is widening. The Italian 10-year bond yield peaked on the 18th March at 2.95%.
Eurobonds would automatically be considered as a natural ‘safe asset’ for the banking sector and investors, having a low yield and reducing borrowing costs for governments. However, as previously said, this will only be possible if a centralized budget is in place.
Germany has always been contrary to the idea of joint debt, fearing moral hazard behaviours on fiscal budgets by other countries.
Other options must be explored:
The European Stability Mechanism.
The European Stability Mechanism (ESM) is a bailout fund that has, according to Klaus Regling, the head of the ESM, an unused lending capacity of 410 billion euros. The ESM has been idle since Greece exited the emergency assistance program. Receiving a financial bail-out from the ESM comes with conditions, varying from structural economic reforms to fiscal belt-tightening. The ESM has assured already their availability to provide funding wherever needed within the Eurozone.
Oil market has been very volatile this week, following its downward trend within the $20/barrel area.
At the start of the week, the API oil inventories in the US were released:
- +10.485 mmbbl (millions of barrels), the biggest inventory build since February 2017.
This is a good indicator to illustrate how oversupplied the oil market is. The consequence (low prices) is already having effect on U.S shale producers.
Has there been any cases of bankruptcies in U.S shale producers?
Shale group Whiting Petroleum filed for bankruptcy protection due to the crash in prices since the Coronavirus emergency started. Some of the independent U.S shale producers are very leveraged and are hiring advisers to try to reduce the debt pile. Whiting Petroleum, for instance, has more than $2.4bn in outstanding bonds maturing in the next six years still after repaying $262m outstanding on a convertible bond. They announced last month a 30% cut in planned spending but it is not enough.
It is probably the reason for Trump’s desperate and misleading tweet before his meeting with the main oil producers in the country: Chevron and ExxonMobil among others. Trump needs to influence oil price in the short-term to be in a strong position in today’s meeting with CEOs.
Is this situation applicable to the rest of oil producers in the world?
Contrary to this whole U.S industry situation, the Russian oil industry seems to remain profitable when oil prices are around $20/bbl, very well positioned for a price war.
The Russian oil industry has various advantages:
- A weakening rouble makes their barrel exports more profitable for a given price in U.S dollars:
- Russian rouble is a free-floating currency unlike the Middle East oil producers whose currency is pegged to the U.S dollar. As oil prices go down, the rouble weakens (less demand for roubles), increasing the domestic producers’ profitability.
- In addition, Russian tax system adjusts with oil prices, so that at less than $25 a barrel, the industry protects and preserves itself. Tax payments are reduced to a minimum.
- And finally, western sanctions on Russia have been favourable for Russian oil companies in this particular situation. They are prepared for a big downturn. Their restricted access to foreign technology and capital obliges them to have most of the costs and liabilities in roubles.
Eventually, the situation in the oil market could slightly improve as China moves forward plans to buy oil barrels for its emergency reserve, a similar move to that from Trump two weeks ago but motivated, given the importer condition of the Asian country, by the fall in prices.
The Shock Impact
China (in the Hubei province case), Europe and the U.S have all missed the early window for social distancing, clearly the only way of slowing the contagion. That early window was crucial for effective and less costly action. Acting when we are further along the disease spread curve means facing higher economic costs. Predictions of what will happen are impossible, this crisis is unprecedented.
Governments have delivered a huge expansionary fiscal policy consisting of double-digit percentages of GDP, piling up more debt in countries that were already highly indebted. For instance, Italy, one of the most affected countries, owed 135% of their GDP before the shock.
The question is:
How will the economic impact path of the shock be and whether the economies will get any structural impact from the coronavirus crisis?
For this, it is valuable to analyse the different shock geometries in history. These are different recoveries in three countries during the global financial crisis.
Misunderstanding the characteristics of this virus can make us believe in a V-shape recovery. In other words, just after the getting to the peak of the virus, a strong recovery of the economy. However, both the known and the unknown information about the potential impact are enough to think otherwise.
- Non-farm payrolls, just released before this blog publication, showed a loss of 701k jobs in the US economy, much worse than expectations that were around 100k. However, this data is already outdated as they compile data until the 13th, 14th March, before the start of the pandemic in the U.S.
- Initial jobless claims in record higher this week. 6.6 million people filed for claims in just one week. Overall, in two weeks, 10 million Americans filed for unemployment claims. It seems some structural consequences for the economies will certainly happen.
- The role of asymptomatic patients is not perfectly understood.
- The way the virus is transmitted is uncertain and so are the true rates of infection and immunity.
- The reaction of firms and households are uncertain.
- Policymakers are responding with old recipes to a completely different crisis.
If right and smart policies are implemented, a U-shape could be plausible. If not, it is likely an L-shape recovery, although less deep than the one depicted previously.
As always, I leave the S&P500 weekly performance map: