~Weekly Overview~

Volatility

OIL AT REAL RISK… WELCOME TO A PRICE WAR

Last week, as anticipated, the OPEC+ meetings that took place to deliver supply cuts in order to stabilise oil prices failed, causing a big drop in the oil market. Russia and Saudi Arabia, main countries of OPEC+ alliance, did not agree in cutting oil supply. During the weekend, a Financial Times report stated that Saudi Arabia was planning to punish Russia for impeding an agreement in the previous meeting. The Kingdom would increase oil production, pumping 10 million barrels per day (BPD), with a possibility to reach 11 million BPD.

We should be aware of where the root of this problem lays. Due to Coronavirus, China, the largest importer of oil in the world, reduced by 20% its oil demand as quarantine expanded throughout the country. The increasing impact of Coronavirus in Western countries will deepen the effect on oil demand.  To respond to a demand shock, if producers want to stabilise prices, they should cut supply.

Unfortunately for them, history repeats.

On 27^th September 2014, despite the Islamic State taking control of large petroleum fields in Iraq and Syria and despite a big reduction in demand for oil forecast, the OPEC decided to keep prices steady to try and fight against US shale producers. In months, the prices dropped to prices below $ 30 from a starting price of $ 110.

This Monday, oil prices dropped 30% overnight becoming the worst sell-off since 1991 although that fall was eventually reduced to 21% in the session.

Here, you can find the fiscal break-even oil prices of the main oil exporters. This shows the minimum price per barrel required by each country to meet its spending needs. In other words, to balance its account. Saudi Arabia now needs extra money to perform its diversification future plans for its economy. They don’t want to depend on oil anymore.

TESTING THE BANKING SYSTEM AFTER A DECADE SINCE THE FINANCIAL CRISIS

Central banks are exhausting its Monetary Policy tools to boost aggregate demand and perpetuate growth, or at least, not falling into a recession.

The Federal Reserve (US Central Bank) is the one that can loose monetary policy the most (within big banks) as they have room for manoeuvre to do it. Indeed, they were the first to respond to the Coronavirus emergency cutting the interest rate by 50bps (0.5%), from 1.75% to 1.25% this 3rd March.

On Wednesday, the Bank of England (BOE) followed suit with another 50bps interest rate cut from 0.75% to 0.25%, deepening the negative real interest rate problem. But the question is:

What can the European Central Bank (ECB) do in terms of interest rates to stimulate a weaken Eurozone economy which is under the worst of Coronavirus after China?

No room for further cuts when you have the deposit interest rate at -0.5%. To respond to Coronavirus, the ECB announced extra €120bn in bond purchases, additional longer-term refinancing operations (cheaper loans for banks) and more favourable terms for existing bank lending schemes. She stated she would not be ‘whatever it takes, number two’ in reference to her predecessor Mario Draghi.

What are the consequences of this ultra-loose monetary policy for the banking system?

Despite having passed toughened stress tests, banks are seeing how their profit margins are reduced more and more. They cannot charge clients for their deposits as that would disincentive them to keep their money in bank accounts, facing a huge liquidity problem as a result. In addition, they are obliged to charge a close-to-zero lending rate which does not give them good returns for the risks they face. The financial industry shares have fall almost twice as much as the S&P500 in the last week around 30% for main banks such as Wells Fargo or Citigroup.

For further analysis on the inefficiency of Monetary Policy when interest rates are low please research the ‘Liquidity Trap Phenomenon’

On Thursday, we experienced one of the biggest sell-off of all time (Source: FT):

As I will always do, I finish this extraordinary week in the financial sector with a detailed map of the S&P500 week performance from Flinviz:

Disclaimer: Do not take any of the opinions shared here as Investment advice. Whenever you want to start investing make sure you do your own research and seek professional advice for any investment decisions you make in the future. Hope you enjoyed the read!