Rabo: When Oil Traded Here Last, The World Was Convulsing Over An Imminent Recession

Submitted by Michael Every of Rabobank

Although the WHO stopped short of calling its spread a ‘global health emergency’ (yet), the market largely took its cues from the news flow on 2019-nCoV and the mounting containment measures by Chinese authorities. A growing number of cities have been put in lockdown as the death toll reached 25. There were also an increasing number of reports of hospitals being overwhelmed with new suspected cases.

A key market which has sharply reversed following the geopolitical turbulence at the start of this year is the oil market. The nearest future for a barrel of Brent dropped to $60, down almost 4% from Wednesday [and back to the level from June 2019 when the world was terrified about an imminent recession].

That, together with the overall risk-off sentiment led to a relatively sharp drop in inflation break-evens (US 10y inflation swap -7bp) and global bond yields. 10Y US Treasury yields fell almost 5bp and similar declines were seen in most European markets. The S&500 managed to churn out a slight uptick (+0.1%) following consistent losses elsewhere around the globe. As the Chinese lunar New Year holiday starts this weekend, which has many people traveling, incoming information about the speed and spread of the virus will have to show whether current containment measures are sufficient. Assessing the economic damage at this stage is extremely difficult and highly speculative, but what many investors may now be asking themselves is whether this external shock can nip the ‘green shoots of recovery’ in global trade and production that have emerged since 2019Q4, in the bud.

With a cautious but slightly more upbeat tone, Ms. Lagarde, speaking in the ECB press conference, clearly was not responsible for the general sentiment in markets. Adorned by an owl brooch, President Lagarde opened yesterday’s ECB press conference saying that it “will be a busy year for us.” Although we expect the Council will be forced to take more action later in the year, we doubt that she meant this in terms of further monetary easing. Indeed, the President sounded a slightly more upbeat tone at today’s meeting. Instead, we believe that she referred to the official announcement of the review of the ECB’s monetary policy strategy.

The ECB viewed the incoming data as in line with their base scenario of ongoing but moderate economic growth. The incoming data therefore resulted in a press conference with a slightly more upbeat tone, as expected. And while the Council continues to see risks tilted to the downside, they noted that these risks “have become less pronounced” – a modest upgrade from the earlier assessment that they “have become slightly less pronounced”.

The main reason for this upgrade was the reduced uncertainty with respect to global trade relations after the US and China signed a phase one deal. Yet, she did add that the ECB’s staff is still assessing the potential impact in terms of diverted trade as a result of the agreement. So even though the ECB was more optimistic owing to the fading of uncertainty, they did acknowledge that there may still be an impact on external demand – which in essence is still a factor of uncertainty for the Eurozone economy. And similarly, the ECB appears to be taking a glass (more than) half full view regarding the potential for a US-EU trade conflict: they expect this to be resolved in an amicable manner and without tariffs. This means that there are mainly risks of trade developments turning out less positive than the Council foresees.

When asked what the ECB would do in case of an economic downturn, President Lagarde emphasised that the ECB would act as needed, regardless of the ongoing strategy review. She did not express preference for any stimulus tool, but reiterated that different instruments work at different parts of the yield curve, and that the Council must ask itself at what point of the curve they want to operate should a downturn materialise. In our minds, rate cuts remain the least contentious instrument in the ECB’s toolkit, and we continue to forecast three more rate cuts, with the next one in June.

Turning to the review of the ECB’s strategic review, yesterday’s press conference was accompanied by a formal statement to announce this process. Nonetheless, this statement contained nothing we didn’t know already. The review will take a broad scope and will “encompass quantitative formulation of price stability, monetary policy toolkit, economic and monetary analyses and communication practices”. Despite earlier reports by Bloomberg that the ECB may set different timelines for certain parts of the review (e.g. first the inflation objective and instruments, and then secondary objectives like climate change), the statement did not confirm this. In fact, no deadline was set at all, and the ECB only states that the review is “expected to be concluded by the end of 2020.”