Will commodity price rises trigger inflation in 2018?

As we begin our journey into 2018 then there has been one clear trend so far as Bloomberg has pointed out this morning.

The Bloomberg Commodities Spot Index, tracking the price of 22 raw materials, jumped to its highest since December 2014 on Thursday. The gauge has risen for a record 14 days in a row.

If we take a look at the underlying data we see that the index has rallied from just below 340 on the 11th of December to 361 as I type this and it has been pretty much one-way traffic. So perhaps ripe for a correction in the short-term but if we look further back we see that it is up 8% on a year ago and that this stronger phase began just under 2 years ago in mid January 2016 when the index dipped below 255. This leaves us with an intriguing conclusion which is that the commodities index saw a strong rally in 2016 just as we were being told inflation was dead as mainstream analysis looked back on the previous downwards trend.

Bloomberg is upbeat on the causes of this recent phase.

The strongest manufacturing activity since the aftermath of the global financial crisis is slowly draining commodities surpluses, sending prices to a 3-year high as investors pour money into everything from oil to copper.

“Rarely has the outlook for a New Year been as encouraging as it is today,” said Holger Schmieding, chief economist at Berenberg Bank in London.

With factories around the world humming, demand for raw materials is fast increasing.

That is an upbeat way of looking at the issue although of course it omits something that in other articles they tell us is important which is the use of finite resources. We get however a clue to their emphasis from this.

Where to make Big Money in Commodities, Energy

I particularly like the way that Big Money is in capitals. Anyway well done to those who had stockpiled commodities. Also there may be a misprint about the chief economist of Berenberg Bank being in London as of course Bloomberg readers will have been told that all such jobs have gone to Frankfurt although they may be further confused by the brand new shiny Bloomberg offices in London! Moving to the Financial Times we also see that good economic news is on their minds.

Markit’s global survey of manufacturing activity rose to a near seven-year high in December, fuelling optimism that 2018 could be another year of strong growth.

Crude Oil

The rally here poses something of a problem for economics/finance themes because as regular readers will recall we were told that the advent of shale oil production would prevent price rises. One part of the analysis was true in that they have indeed produced more oil.

The U.S. Energy Information Administration (EIA) expects U.S. crude oil production to have averaged 9.2 million bpd for all of last year. It expects U.S. crude oil production to average an all-time high of 10.0 million bpd this year, which would beat the current record set in 1970. ( OilPrice.com)

That is of course more than awkward for those who put Peak Oil theories forwards in the 1970s for a start. Moving back to the current oil price what was not forseen was that OPEC will not only announce production cuts but actually go through with the announcements leading to this.

however, oil prices rose steadily in the fourth quarter of 2017 to end the year at above $60 per barrel WTI and $66 per barrel Brent.

Brent Crude Oil nudged over US $68 per barrel earlier today or as high as it has been for two and a half years. At such a level we see that there is good news for oil producers of all sorts.Firstly there must be something of a bonanza for the shale oil producers with the cash flow style business model we have previously analysed. But also there will be all sorts of gains for the more traditional oil producers in the Middle East as well as Canada and Russia. There has been an irony in that the pipeline shutdown for the UK Forties field meant that Brent production could not benefit from higher Brent prices but that is now over.

Inflation

Last September an International Monetary Fund ( IMF) working paper looked at how oil price moves affected inflation.

 We find that a 10 percent increase in global oil inflation increases, on average, domestic inflation by about 0.4 percentage point on impact, with the effect vanishing after two years and being similar between advanced and developing economies.

There was also some support for those who think that the effect is stronger when prices rise.

We also find that the effect is asymmetric, with positive oil price shocks having a larger effect than negative ones

The results also vary from country to country as the impact on the UK is double that of the impact on the United States although this may be influenced by 1970s data when the UK Pound £ would have acted like the Great British Peso on any oil price rise.

As an aside I would like to remind everyone of the way a surge in the oil price contributed to the economic effects of the credit crunch, something which tends to get forgotten these days. On that road the credit crunch era becomes easier to understand and the establishment mantra which this IMF paper repeats becomes more questionable.

The has declined over time, mostly
due to the improvement in the conduct of monetary policy.

A darker road can be found if we look at the impact of bank commodity trading desks back then because if as I believe they drove oil prices higher there is a raft of questions to add to the other scandals we have seen such as Li(e)bor and foreign exchange rigging.

Metals

There has been a raft of news about these hitting new highs and let us start with what Dr,Copper is telling us.

Copper gained 30%  in 2017 as it continues to recover from six-year lows struck early last year……… Measured from its multi-year lows struck at the beginning of 2016, copper has gained more than 70% in value. ( Mining.com)

Palladium has been hitting all-time highs this week. If we look deeper we see that metals prices have been rising overall as the CRB metals index which was conveniently at 800 this time last year is at 912 as I type this.

Comment

There are various factors to consider here but let me open with a word not in frequent use in the credit crunch era which is reflation. We are seeing a stronger economic phase ( good although there is the underlying finite resources issue) but how much of this higher demand will feed into inflation may be the next question? There have been signs of Something Going On as Todd Terry would put it. From the Composite PMI or business survey for the Euro area.

The pace of inflation signalled for each price
measure remained strong relative to their long-run
trends, however, and among the steepest seen over
the past six-and-a-half years.

Also for the UK services sector.

Input price inflation reached its highest level since
last September, with service providers noting
upward pressures on costs from a wide range of
sources.

Moving to a different perspective some seem to be placing their betting chips in the US according to the Financial Times.

Investors pour money into funds that protect against inflation

Also there will be wealth and GDP shifts in favour of commodity producers and from those that consume them. The obvious beneficiary is much of the Middle East but others such as Australia, Canada and Russia will be smiling and that is before we get to the US shale oil producers who have been handed a lifeline. It also reminds me that the Chinese effort to get control of commodities around the world and particularly in Africa looks much more far-sighted than us western capitalist imperialists have so far managed. That is something which will particularly annoy Japan which of course is a large loser as commodity prices rise due to its lack of natural resources as its own more violent and aggressive efforts in this field badly misfired in the 1940s.

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What is happening to the economy of Qatar?

Today I intend to take a look at the economy of one of the Gulf states Qatar. It hit the news earlier this month due to these events from Gulf News.

June 5: The UAE, Bahrain, Saudi Arabia, and Egypt cut diplomatic ties with Qatar, accusing Doha of supporting extremism, and giving the countries’ diplomats 48 hours to leave.

June 6: WAM, the UAE state news agency, announces that the country has closed its seaports, as well as its airspace, to all Qatari vessels and airplanes.

So it went into the bad boy/girl camp as diplomatic and economic sanctions were applied. Although in the topsy-turvy world in which we live this happened soon after.

Qatar will sign a deal to buy as many as 36 F-15 jets from the U.S. as the two countries navigate tensions over President Donald Trump’s backing for a Saudi-led coalition’s move to isolate the country for supporting terrorism.

Qatari Defense Minister Khalid Al-Attiyah and his U.S. counterpart, Jim Mattis, completed the $12 billion agreement on Wednesday in Washington, according to the Pentagon.

The sale “will give Qatar a state of the art capability and increase security cooperation and interoperability between the United States and Qatar,” the Defense Department said in a statement.

I do not know about you but if I thought that someone was indeed sponsoring terrorism I would not be selling them fighter jets! Still I suppose it does help achieve one of the Donald’s main aims which is to boost US manufacturing.

Also whilst we are on the subject of “Madness, they call it madness” there was of course the decision to award the 2022 football World Cup to a country with extraordinarily high temperatures. Also one could hardly claim that football was coming home!

How was the Qatari economy doing?

There was a time when it was party, party, party. From the Financial Times.

ministers used to boast about the economy expanding at one of the fastest rates in the world: in the decade to 2016, growth averaged 13 per cent.

Much of this was of course due to higher prices for crude oil and associated products which then changed.

The oil crash in 2014 hastened a spending review, with budget cuts and widespread redundancies across the energy and government sectors, including thousands at the state petroleum group. Jobs have been cut in museums and across education, media and health, with many projects cancelled or delayed.

There was something of a familiar feature to this.

In the West Bay business district, the impact of shrinking corporate and residential demand is stark. The flagship development boomed from 2004 to 2014 but the area is now littered with unoccupied and half-built skyscrapers.

The World Cup Boomlet

Work on this has turned out to be anti-cyclical and has provided a boost.

The Gulf state is building nine sports stadiums, “cooled” fan zones, hotels, sewage works and roads ahead of the football tournament……the government is spending $500m a week on World Cup-related infrastructure.

However there was a consequence.

Qatar, the world’s top exporter of liquefied natural gas, recorded its first budget deficit in 15 years in 2016 — a $12bn financing gap

Oil

This and its related products are the driver of the economy as OPEC notes.

Oil and natural gas account for about 55 per cent of the country’s gross domestic product. Petroleum has made Qatar one of the world’s fastest-growing and highest per-capita income countries.

There are various different measures but Global Finance puts it as the world’s highest per capita GDP in 2016. Of course this wealth mostly simply emerges from the ground mostly in the form of natural gas.

Of course the fact that the price of a barrel of Brent Crude Oil has fallen below US $45 is not welcome in Qatar as it reduces GDP, exports and government revenue. Also since May the price of natural gas has been falling with the NYMEX future dropping from US $3.42 to US $2.89. So bad times on both fronts as Qatar mulls the impact of the US shale oil producers.

Monetary Policy

You might have been wondering why there have not been reports of a crashing Qatari Rial. That is because of this. From the Qatar Central Bank.

QCB has adopted the exchange rate policy of its predecessor, Qatar Monetary Agency, through fixing the value of the Qatari Riyal (QR) against the US dollar (USD) at a rate of QR 3.64 per USD as a nominal anchor for its monetary policy.

So we have a type of fixed exchange rate or if you prefer a currency peg. This means that monetary policy is in effect imported from the United States which led to this.

Qatar Central Bank has decided to raise its QMR Deposit rate (QMRD) on Thursday June 15,2017 By 25 basis point from 1.25% to 1.50% .

Even in these times of low interest-rates one of 1.5% is hardly going to cut it in terms of currency support so minds immediately turn to the foreign exchange reserves. The QCB had 125.4 billion Riyals at the end of April. This was down on the recent peak of 158.3 billion Riyals of July 2015 presumably due to responses to the lower oil price. This meant that a balance of payments current account surplus of 50.1 billion Riyals of 2015 became a 30.3 billion deficit in 2016.

At a time like this people will also note that the external debt of the Qatari government rose from 73.4 billion Rials at the end of 2105 to 116.2 billion at the end of 2016. Also the banking sector has become more dependent on foreign cash according to Reuters.

Qatar’s banks became dependent on foreign funding during the last few years of strong economic growth. Their foreign liabilities increased to 451 billion riyals (97.90 billion pounds) in March from 310 billion riyals at the end of 2015.

Also if we look back to the 13th of this month I noticed this in the statement from the QCB saying that the banking sector was operating normally, which of course usually means it isn’t!

that QCB has sufficient foreign currencies reserves to meet all requirements.

So presumably it has been using them.

Qatar Investment Authority

The QIA manages a portfolio estimated at around US $335 billion and at a time like this investing abroad will look rather clever in foreign currency terms. Although the exact list may not be entirely inspiring.

Main assets include Volkswagen, Barclays, Canary Wharf, Harrods, Credit Suisse, Heathrow, Glencore, Tiffany & Co., Total.

There is speculation that there is pressure to use these assets. From Reuters.

Qatar’s sovereign wealth fund has transferred over $30 billion worth of its domestic equity holdings to the finance ministry and may sell other assets as part of a restructuring drive, people familiar with the matter told Reuters.

As someone who cycled past one of those assets – Chelsea Barracks –  only yesterday that provides food for thought for the London property market I think.

Comment

The discussion so far has been about financial issues so let us look at a real economy one which could not be more Arabic.

Saudi blockade on Qatar sabotages multi-billion dollar camel ……….A rescue mission is underway in Qatar after thousands of camels were expelled from Saudi Arabia due to the ongoing blockade. each of them can be worth up to $75,000  ( Al Jazeera )

Also food is being sent from Turkey.

Turkey is sending food supplies to Qatar by sea on Wednesday to compensate for a recent embargo by Qatar’s neighbour states, according to Turkey’s economy minister. (Al Jazeera )

At least it is better than sending soldiers which is unlikely to improve anything. But if we move back to the financial impact we wait to see how much has been spent to support the currency. We can see from the forward rates that there must have been some and maybe a lot. Also is it a coincidence that the UK looks to be taking the investment in Barclays to court? On that subject this from The Spectator is quite extraordinary.

Why I’m sad to see Barclays in the dock, and astonished to see John Varley there

Apparently he should not be there because he was “impeccably well tailored and mannered, who always looked destined for the top — but was also universally liked by his colleagues” something which could have come straight from the satire and comedy about “nice chaps” in Yes Prime Minister.

Meanwhile with the UK weather and the subject of today it is time for some Glenn Frey.

The heat is on (yeah) the heat is on, the heat is on
(Burning, burning, burning)
It’s on the street, the heat is on

Me on TipTV Finance

http://tiptv.co.uk/car-loans-canary-coal-mine-not-yes-man-economics/

What are the latest trends for inflation?

It is time to review one of the themes of 2017 which is that we expected a pick-up in the annual rate of inflation around the world. This has been in play with the US CPI rising at an annual rate of 2.4% in March and the Euro area CPI rising at 1.9% in April for example. If we switch to the factor that has been the main player in this we see that energy prices were 10.9% higher in the US than a year before and that in the Euro area they had gone from an annual rate of -8.7% in April last year to 7.5% this April. If we look at my own country the UK then the new headline inflation measure called CPIH ( where H includes an Imputed Rent effort at housing costs) then inflation has risen from 0.2% in October 2015 to 2.3% in March. So we see that the US Federal Reserve and the Bank of England have inflation above target and the ECB on it which means two things. Firstly those who went on and on about deflation a couple of years ago were about as accurate as central banking Forward Guidance . Secondly that we can expect inflation in the use of the words “temporary” and “transitory”!

Crude Oil

There has been a change in trend here indicated this morning by this from @LiveSquawk.

Saudi OPEC Governor: Based On Today’s Data, There Is Growing Conviction That 6-Month Extension May Be Needed To Re-balance The Market

You may recall that what used to be the world’s most powerful cartel the Organisation of Petroleum Exporting Countries or OPEC met last November to agree some output cuts. These achieved their objective for a time as the price of crude oil rose however this was undermined by a couple of factors. The first was that it was liable to be a victim of its own success as a higher oil price was always likely to encourage the shale oil wildcatters especially in the United States to increase production. This would not only dampen the price increase but also reduce the relative importance of OPEC. As you can see below that has happened.

U.S. crude production rose to 9.29 million barrels last week, the highest level since August 2015, according to the Energy Information Administration. (Bloomberg).

Also doubts rose as to whether OPEC was delivering the output cuts that it promised. For example they seem to be exporting more than implied by their proclaimed cuts. From the Financial Times.

Analysts at Energy Aspects say tanker tracking data suggests Opec’s exports have fallen by as little as 800,000 b/d so far in 2017 as some members have supplanted oil lost to production cutbacks with crude from storage, or have freed up barrels for export as they carry out maintenance at domestic refineries.

On the other side of the coin there is the fact that for a given level of output we need less oil these days and an example of this comes from the Financial Post in Canada today.

Canada substantially boosted its renewable electricity capacity over the past decade, and has now emerged as the second largest producer of hydroelectricty in the world, a new report said Wednesday.

So the trajectory for oil demand looks lower making the “balance” OPEC is looking for harder to achieve.

Other commodities

We get a guide to this if we look to a land down under as the Reserve Bank of Australia has updated us in its monetary policy today.

Beyond the next couple of quarters, prices of bulk commodities are expected to decline………Consistent with previous forecasts, iron ore prices have already fallen significantly in the past few weeks.

The RBA also produces an index of commodity prices.

Preliminary estimates for April indicate that the index decreased by 3.5 per cent (on a monthly average basis) in SDR terms, after decreasing by 1.7 per cent in March (revised). A decline in the iron ore price more than offset an increase in the coking coal price. Both the rural and base metals subindices decreased slightly in the month. In Australian dollar terms, the index decreased by 2.0 per cent in April.

So the rally seems to be over and the index above was inflated by supply problems for coal which drove its price higher. As to Iron Ore the Melbourne Age updates us on what has been going on.

Spot Asian iron ore prices have performed worse than Chinese steel rebar futures in recent weeks, dropping 31 per cent from a peak of US$94.86 a tonne on February 21 to US$65.20 on Thursday.

If we switch to Dr. Copper then the rally seems to be over there too although so far the price drops have been relatively minor.

What about food prices?

The United Nations updated us yesterday on this.

The FAO Food Price Index* (FFPI) averaged 168.0 points in April 2017, down 3.1 points (1.8 percent) from March, but still 15.2 points (10 percent) higher than in April 2016. As in March, all commodity indices used in the calculation of the FFPI subsided in April, with the exception of meat values.

As ever there are different swings here and of course the swings remind us of the film Trading Places. There was a time that these looked like the most rigged markets but of course there is so much more competition for such a title these days including from those who are supposed to provide fair markets ( central banks ).

Comment

There is a fair bit to consider here as we look forwards. There is always a danger in using financial markets too precisely as of course sharp falls like we have seen this week are often followed by a rebound. But it does look as if the commodity price trajectory has shifted lower which is good for inflation trends which is likely to boost economic growth compared to otherwise. Of course there are losers as well as winners here as commodity producers lose and importers win. But overall we seem set to see a bit less inflation than previously predicted and over time a little more economic growth.

As to the impact of a falling crude oil price on inflation the UK calculates it like this and I would imagine that many nations are in a similar position.

A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.02 percentage points to the 1-month change in the CPIH.

There are of course also indirect effects on inflation from lower energy prices as well as other direct effects such as on domestic fuel bills. For the UK itself I estimated that inflation would be around 1.5% higher due to the EU leave due to the lower level of the Pound £ and for that to weaken economic growth. So for us in particular any dip in worldwide inflation is welcome as of course is the rise in the UK Pound £ to US $1.29.

A (space) oddity

We are using electronic methods of payment far more something which I can vouch for. However according to the Bank of England we are also demanding more cash.

Despite speculation to the contrary, the number of banknotes in circulation is increasing. During 2016, growth in the value of Bank of England notes was 10%, double its average growth rate over the past decade.

Who is stocking up and why? Pink Floyd of course famously provided some advice.

Money, it’s a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I’ll buy me a football team

Share Radio

Sadly it comes to an end today and in truth it has been winding down in 2017. As someone who gave up his time to support it let me say that it is a shame and wish all those associated with it the best for the future.

 

2017 is seeing the return of the inflation monster

As we nearly reach the third month of 2017 we find ourselves observing a situation where an old friend is back although of course it is more accurate to describe it as an enemy. This is the return of consumer inflation which was dormant for a couple of years as it was pushed lower by falls particularly in the price of crude oil but also by other commodity prices. That windfall for western economies boosted real wages and led to gains in retail sales in the UK, Spain and Ireland in particular. Of course it was a bad period yet again for mainstream economists who listened to the chattering in the  Ivory Towers about “deflation” as they sung along to “the end of the world as we know it” by REM. Thus we found all sorts of downward spirals described for economies which ignored the fact that the oil price would eventually find a bottom and also the fact that it ignored the evidence from Japan which has seen 0% inflation for quite some time.

A quite different song was playing on here as I pointed out that in many places inflation had remained in the service-sector. Not many countries are as inflation prone as my own the UK but it rarely saw service-sector inflation dip below 2% but the Euro area for example had it at 1.2% a year ago in February 2016 when the headline was -0.2%, Looking into the detail there was confirmation of the energy price effect as it pulled the index down by 0.8%. Once the oil price stopped falling the whole picture changed and let us take a moment to mull how negative interest-rates and QE ( Quantitative Easing) bond buying influenced that? They simply did not. Now we were expecting the rise to come but quite what the ordinary person must think after all the deflation paranoia from the “deflation nutters” I do not know.

Spain

January saw quite a rise in consumer inflation in Spain if we look at the annual number and according to this morning’s release it carried on this month. Via Google Translate.

The leading indicator of the CPI puts its annual variation at 3.0% In February, the same as in January
The annual rate of the leading indicator of the HICP is 3.0%.

Just for clarity it is the HICP version which is the European standard which is called CPI in the UK. It can be like alphabetti spaghetti at times as the same letters get rearranged. We do not get a lot of detail but we have been told that the impact of the rise in electricity prices faded which means something else took its place in the annual rate. Also we got some hints as to what is coming over the horizon from last week’s producer price data.

The annual rate of the General Industrial Price Index (IPRI) for the month of January is 7.5%, more than four and a half points higher than in December and the highest since July 2011.

It would appear that the rises in energy prices affected businesses as much as they did domestic consumers.

Energy, whose annual variation stands at 26.6%, more than 18 points above that of December and the highest since July 2008. In this evolution, Prices of Production, transportation and distribution of electrical energy and Oil Refining,
Compared to the declines recorded in January 2016.

In fact the rise seen is mostly a result of rising commodity prices as we see below.

Behavior is a consequence of the rise in prices of Product Manufacturing Basic iron and steel and ferroalloys and the production of basic chemicals, Nitrogen compounds, fertilizers, plastics and synthetic rubber in primary forms.

The Euro will have had a small impact too as it is a little over 3% lower versus the US Dollar than it was a year ago.

Belgium

The land of beer and chocolate has also been seeing something of an inflationary episode.

Belgium’s inflation rate based on the European harmonised index of consumer prices was running at 3.1% in January compared to 2.2% in December.

The drivers were mostly rather familiar.

The sub-indices with the largest upward effect on inflation were domestic heating oil, motor fuels, electricity, telecommunication and tobacco.

These two are the inflation outliers at this stage but the chart below shows a more general trend in the major economies of the Euro area.

The United States

In the middle of this month the US Bureau of Labor Statistics confirmed the trend.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6 percent in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics
reported today. Over the last 12 months, the all items index rose 2.5 percent before seasonal adjustment.

This poses some questions of its own in the way that it confirmed that the strong US Dollar had not in fact protected the US economy from inflation all that much. The detail was as you might expect.

The January increase was the largest seasonally adjusted all items increase since February 2013. A sharp rise in the gasoline index accounted for nearly half the increase,

Egypt

A currency plummet of the sort seen by the Egyptian Pound has led to this being reported by Arab News.

Inflation reached almost 30 percent in January, up 5 percent over the previous month, driven by the floatation of the Egyptian pound and slashing of fuel subsidies enacted by President Abdel-Fattah El-Sisi in November.

Ouch although of course central bankers will say “move along now……nothing to see here” after observing that the major drivers are what they call non-core.

Food and drinks have seen some of the largest increases, costing nearly 40 percent more since the floatation, figures from the statistics agency show. Some meat prices have leaped nearly 50 percent.

Comment

There is much to consider here and inflation is indeed back in the style of Arnold Schwarzenegger. However some care is needed as it will be driven at first by the oil price and the annual effect of that will fade as 2017 progresses. What I mean by that is that if we look back to 2016 the price of Brent Crude oil fell below US $30 per barrel in mid-January and then rose so if the oil price remains around here then its inflationary impact will fade.

However even a burst of moderate inflation will pose problems as we look at real wages and real returns for savers. If we look at the Euro area with its -0.4% official ECB deposit rate and wide range of negative bond yields there is an obvious crunch coming. It poses a particular problem for those rushing to buy the German 2 year bond as with a yield of 0.94% then they are facing a real loss of around 5/6% if it is held to maturity. You must be pretty desperate and/or afraid to do that don’t you think?

Meanwhile so far Japan seems immune to this, of course there will eventually be an impact but it is a reminder of how different it really is from us.

UK National Statistician John Pullinger

Thank you to John and to the Royal Statistical Society for his speech on Friday on the planned changes to UK inflation measurement next month. Sadly it looks as if he intends to continue with the use of alternative facts in inflation measurement by the use of rents to measure owner-occupied housing costs. These rents have to be imputed because they do not actually  exist as opposed to house prices and mortgage costs which not only exist in the real world but are also widely understood.

The oil price shock is affecting Nigeria badly

The economic feature of the last 18 months or so has been the lower oil price and as time has gone by the much lower oil price. Overall this is beneficial to the world economy but producers such as many states in the Middle East, Russia and parts of the United States and Canada are seeing a deflationary impact. However there has also been a deflationary shock to the African countries which produce crude oil and one of them in particular has responded in an unusual manner in monetary terms so step forwards Nigeria.

An appreciating exchange rate?

The situation here is quite unusual as it is quite rare to see an appreciating exchange-rate for an oil producer in response to lower oil prices. Actually as the exchange rate is regularly reported as being fixed you may wonder how it has risen at all but we get the answer from last week’s report from the Central Bank of Nigeria.

The exchange rate at the interbank market opened at N197.00/US$ and closed at N197.00, with a daily average of N196.99/US$ between November 23 and January 11, 2015.

Okay so we have a fixed exchange-rate against the US Dollar which means that as it has risen it has taken the Nigerian Nairu with it. At a time like this that seems rather like one of the cunning plans issued by Baldrick in the television series Blackadder! Nonetheless this remains policy although of course Friday’s move by the Bank of Japan showed us that policy promises only a week old can be reversed.

It also reiterated its commitment to maintaining stability in the naira exchange rate.

This new period of what has turned out to be an exchange-rate appreciation of AROUND 6% followed two devaluations where the Naira was devalued by 8% in November 2014 and then by 17% in February of 2015. Talk about a confused situation or if you like something of a shambles! Even fixed exchange rates are not what they used to be in the credit crunch era or to be more precise in fact this is a currency pegged to the US Dollar and right now that is not a good place to be for an oil producer like Nigeria.

The next issue for a pegged currency is what is the size of your foreign exchange reserves? From the Financial Times.

The central bank’s foreign exchange reserves have nearly halved to $28.2bn from a peak of almost $50bn just a few years ago. A rainy-day fund that had $22bn in it at the time of the 2008-09 global financial crisis now has a balance of $2.3bn.

Let us remind ourselves that the rate of decline for official exchange reserves is as important as the total and in fact more so as they shrink. Also that the issue is more important for a pegged exchange rate than a floating one. Added to this are the problems highlighted this morning by The Premium Times.

the parallel market sells dollars to those who would buy at N305

So not 196.6 then? Oh and the exchange-rate numbers may not be all they are cracked up to be either.

First, the US$28bn balance on the foreign reserve account is almost nearly fictional.

The reason given for this is that the Central Bank has obligations such as letters of credit futures and swaps which are not acccounted for.

So as we sweep up we have a country which officially has an appreciating currency in reality has one which has depreciated.

Inflation

The theme that in fact there has been a devaluation in practice gets some support from the numbers below.

The Committee noted the slight uptick in year-on-year headline inflation to 9.6 per cent in December, from 9.4 per cent in November and 9.2 per cent in October, 2015.

As is often the case the poorest are those that are hardest hit as I note this development.

food inflation inched up to 10.32 per cent from 10.13 and 10.2 per cent over the same period.

In a world of zero and in some cases negative inflation you only get the numbers above from a lower currency so let us mark that and move on.

Economic growth

At first the situation looks rather good especially if we compare it to the West.

Domestic output growth in 2015 remained moderate. According to the National Bureau of Statistics (NBS), real GDP grew by 2.84 per cent in the third quarter of 2015, almost half a percentage point higher than the 2.35 per cent recorded in the second quarter.

However for Nigeria this represents quite a slow down as the rate of economic growth reported was pre oil price drop more like 5-6%. This is a direct consequence of the fact that some 11% of Nigerian economic output was the production of crude oil. Not only is that now lower but of course there will be secondary job losses as the impact filters through other parts of the economy.

Corruption

Price Waterhouse declared this over the weekend.

Our results show that corruption in Nigeria could cost up to 37% of GDP by 2030 if it’s not dealt with immediately. This cost is equated to around $1,000 per person in 2014 and nearly $2,000 per person by 2030.

So with a country of 174 million people the current cost is of the order of US $174 billion which is a large sum for what is still a poor country. Or to put it another way.

Nigeria’s GDP could have been 22% higher in 2014 if it had reduced corruption to Ghana’s levels.

Of course this is an issue for most of Africa. On a personal level my involvement in athletics leads me to chat to athletes who have been out to train in the Rift Valley area and each one reports the same sad experience. So there is food for thought in the fact that Nigeria underperforms what is a sad benchmark.

Added to this is the corruption surrounding the oil production where believe it or not gangs smash the pipelines to filter off oil and just leave it. So not only is there larceny and theft on a grand scale there is an environmental and ecological disaster too as the oil pours out. In addition to this individuals wheel drums of stolen oil around in the cities and try to sell it and from time to time they explode. From Bribe Nigeria.

The finance minister, Ngozi Okonjo-Iweala, a genuine reformer, has estimated that 400,000 barrels of oil a day were stolen in April.

A cry for help

This started in a by now familiar manner as The Nation reports.

Minister of Finance Mrs. Kemi Adeosun last night refuted a report published by Financial Times suggesting that Nigeria has applied for emergency loans from the World Bank and the African Development Bank.

Ah an official denial! We know what happens next don’t we? Anyway let us look at the Financial Times.

Nigeria has asked the World Bank and African Development Bank for $3.5bn in emergency loans to fill a growing gap in its budget in the latest sign of the economic damage being wrought on oil-rich nations by tumbling crude prices.

 

The problem is that around 70% of government revenues came from the oil sector and of course that was at a price of US $100+ and not the mid to low US $30s. They must have more than halved and Nigeria will either have to find another source of revenue or borrow more. The rationale behind borrowing from International organisations like the World Bank is that the interest-rate is likely to be a fair bit below market rates for Nigeria.

Today

Something of note is happening in Nigeria today which is against even the policies of UK domestic ebergy companies who are belatedly cutting prices. From AllAfrica.

Under the new tariff, residential customer category (R2) in the Federal Capital Territory (FCT), Niger, Nasarawa and Kogi states, which fall under the Abuja Electricity Distribution Company (AEDC) franchise, who previously paid N14 per kilowatt/hour, will now pay N23.60 per kilowatt/ hour.

Maybe they will even bill customers properly.

The new tariff order, aside from eliminating fixed charge, has a robust mechanism to ensure that electricity distribution companies fully meter their consumers and eliminate ‘crazy’ billing within one year,” Akah said.

Comment

We see that Nigeria is in quite a mess. The fall in the oil price has exposed the ongoing problems of corruption there and it is corruption on a grand scale. We find ourselves wondering if this should be added to the definition of “Dutch Disease” as the present of oil and gas resources has in effect allowed the corruption to flourish in the background. Those who are corrupt have profited in large amounts as eyes turn again to the Swiss banks. Meanwhile the ordinary Nigerian has been cheated and now with higher food and energy prices is suffering again.

Economically we have a currency which is officially higher but in reality is lower a deflationary burst and an budget deficit. There was a time that this was be a job for the International Monetary Fund. But under its French Managing Directors Dominique Strauss-Khan and  Christine Lagarde it has twisted itself towards the needs of the Euro and away from its original modus operandi. Nigeria could so with the help of an old-style IMF.

 

The impact of the ever disappearing crude oil price

One of the features of the economic landscape since the summer of 2014 has been the falling oil price. If we look back it feels that the price of just below US $116 per barrel for Brent Crude Oil is from another economic world and of course that is true now. But back in late June 2014 it flirted with such levels after even higher prices and of course forecasts. Goldman Sachs were (in)famous for calling for US $200 oil in 2008 and in 2011 Nomura stepped up to the plate.

If Libya and Algeria were to halt oil production together, prices could peak above US$220/bbl…… we estimate oil could fetch well above US$220/bbl, should Libya and Algeria stop production.

How much is well above please? Anyway I introduced some past forecasting perspective because this week has already seen some efforts at forward guidance on this front. From Bloomberg.

A rapid appreciation of the U.S. dollar may send Brent oil to as low as $20 a barrel, according to Morgan Stanley….“Given the continued U.S. dollar appreciation, $20-$25 oil price scenarios are possible simply due to currency,”

Oh and a familiar firm had already predicted such a number.

Goldman Sachs Group Inc. has said there’s a possibility storage tanks will reach their limit, pushing crude down to levels necessary to force an immediate halt to some production.

An easy one for the spreadsheets as all they had to do was remove a zero from the past spreadsheets as I guess we are all reminded about the “Muppet” scandal. In such a situation what is an investment bank to do? Well this is the solution from Standard Chartered via Reuters.

“We think prices could fall as low as $10/bbl before most of the money managers in the market conceded that matters had gone too far,” it added.

Should it happen then one contributor may finally be happy with the oil price 🙂

Where are we now?

The first wave of the oil price fall took us down into the mid 40s in terms of the US Dollar and it did so around this time last year. following that there was a bounce to nearly US $70 but then the move acquired a second wind. Since the middle of May 2015 the oil market has again acquired a taste for the repetitive rhythms of Status Quo.

Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down

This morning Brent Crude Oil dipped below US $31 per barrel finding itself going back in time to 2004 as it did so. There has been around a 20% fall this January alone and market volumes have been very high. Combining this with the rumours of an emergency OPEC meeting which have just arisen makes me wonder if someone is what is called “long and wrong” in size? I will return to this issue later. But for now we return to an oil price which is much lower.

The impact on inflation

If we start with producer prices then most input numbers have been blitzed by this. for example we have been reminded of this today by the UK’s poor manufacturing numbers.

Input prices paid by UK manufacturers fell by 13.1% in the year to November 2015……..Over the past year the manufacturing industry has experienced deflation, in terms of the prices manufacturers pay for materials and fuels used in the production process (input prices) and the prices they charge for the goods they produce (output prices).

As UK manufacturing has fallen over the year for once the deflation moniker has some justification. I covered the problems there back on December second of last year.

There is also the impact on consumer inflation which we can look at from today’s official data on fuel prices at the pump. The price of petrol at 101.9 pence is some 7 pence lower than a year ago and the price of diesel at 103.4 pence is some 12.8 pence lower than a year ago. So not only are we seeing a price fall there is a welcome price bias for diesel drivers like me. The direct impact on consumer inflation is show below.

A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.03 percentage points to the 1-month change in the CPI.

As you can see in just very round numbers we are looking at a 0.3% push lower from the direct effect and of course there are many other effects. There is the direct effect on domestic energy costs -well hopefully anyway- and lots of indirect influences on fares and transport costs. But the fundamental point is that an influence which might have faded in the latter part of 2015 is pushing into the early part of 2016.

This will be an influence on central bank and indeed Bank of England policy as it continues to pull us away from the 2% per annum CPI inflation target.

Economic activity

There are various routes as to how a lower oil price can benefit an economy. On the 29th of January last year I explained how I expected lower inflation to boost real wages and lead to a boost in consumption in the UK ( and Ireland and Spain). That proved to be true and has been in evidence in quite a lot of places although its impact on the United States has been relatively weak.

If we look at the overall impact then Price Waterhouse estimated this last March for the UK.

in Scenario 1, where the oil price remains persistently low at US$50 per barrel between 2015 and 2020, the initial impact will raise the level of real UK GDP by around 1.2% in the first year.

We have had that of sorts and are now facing the possibility of a sustained oli price that is even lower although of course matters are volatile. But the theme here is of an economic boost which also will get a second wave if oil prices remain at current levels or fall further.

For the UK there has also been something of a (space ) oddity from the oil price fall. Take a look at this from today’s poor production numbers.

There were increases in 3 of its 4 main sectors, with the largest contribution coming from mining & quarrying, which increased by 10.5% (on last November).

Curious is it not? I will have to enquire again as I am not sure that the impact of the maintenance cycle can fully explain this ongoing rise. You see if we look back UK oil and gas production has been in secular decline.

mining & quarrying and electricity, gas, steam & air conditioning, which continued to decline following the downturn, were 29.4% and 9.1% below their respective values in Quarter 1 (Jan to Mar) 2008.

A transfer from producers to consumers

Not everybody has gained from the oil price fall as producers have been hit hard. This has appeared in the news in various guises from the falls of the Russian Ruble to the budget problems and currency issues of Saudi Arabia to problems for parts of Africa. There must be issues for Canada as well as its tar sands oil has an even lower price than the ones quoted above.

So there are implications here from a transfer of economic gains or to be more specific lower transfers from consumers to producers. In our highly stressed world we have to question if our system can take it.

Derivatives, derivatives

The issue here is of what has become called a Black Swan event which is certainly easier to type than the serially uncorrelated error term! If we return to the concept of our stressed world then an obvious issue is the economic model of the US shale producers which looks to have been essentially a cash flow projection except much of the cash has dried up. There will be trouble ahead with anything like the current oil price and the only question is how much?

The indirect issue comes from my old line of work in derivatives. With oil at US$100+ and projections for US $200+ what could go wrong with writing some US $70 or US $60 put options? Free money isn’t it? Oh hang on…….

Big moves in our financially stressed world lead to fears that some have been caught out and the size of the move would be the prospective problem.

Comment

In ordinary times then for most nations the oil price fall would be nearly unambiguously good news. The fly in the ointment would be a reduction in demand from the oil producing nations and areas. So we continue with the associated good news of lower inflation and higher economic output as the impact of an improved real wage position is felt.

The danger is that in the race for “yield and returns” someone has been a combination of silly and desperate and done so in a large volume. Fingers crossed.

 

 

 

 

Why I welcome the fact that ECB QE has been a failure in its main objective

It is now nearly a year since Mario Draghi and the European Central Bank fired the starting gun on a large-scale move into Quantitative Easing. After its Christmas break it has this week resumed its 60 billion Euro’s per month of bond purchases as it chomps away on Euro area debt like a Pac-Man. In the meantime the period for which it will exist has been extended from September this year to March 2017. So it is time for us to take a look back over this period and see what has been achieved. For those wondering why I defined it as the beginning of large-scale QE it is because the purchases of Greek,Irish and Portuguese debt fitted the bill on a smaller scale as did the two efforts at covered bond purchases. As an aside it is an irony of sorts to see complaints that Greece is not part of the new program as of course there is so little left to buy as around 80% of it is in official hands.

Economic activity

The position here is one that this morning has received some good news. The latest Purchasing Managers Index survey is optimistic looking forwards.

The eurozone economy ended 2015 on a positive note, with the rate of expansion in output rising to a four-month high and growth over the final quarter as a whole the quickest in four-and-a-half years. The expansion was broad-based, with December seeing activity rise across Germany, France, Italy, Spain and Ireland.

So you can see that the survey was bullish for a good 4th quarter which is in stark comparison to the United States where expectations for the same time period have fallen. It is also nice for once to see Italy have some genuine hopes of an improvement. But as the results of the survey progress some of the optimism disappears.

However, despite the improvement, the survey data signal a modest 0.4% increase in GDP in the fourth quarter, which would mean the eurozone grew 1.5% in 2015.

If correct this poses something of a problem for the ECB and let me illustrate this with quarterly economic growth since the beginning of 2014. It goes 0.2%,0.1%,0.3%,0.4%,0.5%,0.4% and 0.3%. The uplift began some 6 months before QE began and you could easily argue that it has made little or no difference so far. That would be not so dissimilar to the UK experience, as for all the hype about Bank of England QE the boost to the housing market via the Funding for Lending Scheme would never have happened if QE was working as advertised.

The crude oil effect

If we look at the improvement in the Euro area economic growth trajectory then it fits much more neatly with the fall or if you prefer plummet in the price of crude oil and other commodities which has taken place. Brent Crude Oil nearly touched US $116 in late June 2014 but was below US $50 at the year-end. I have argued before that this boosts consumption via such factors as higher real wages as it cuts consumer inflation so let us take a look.

In October 2014 compared with September 2014, the seasonally adjusted volume of retail trade rose by 0.4% in the euro area…….In October 2015 compared with October 2014 the retail sales index increased by 2.5% in the euro area

Whilst correlation does not prove causation the improvement in retail sales and consumption in the Euro area fits a lower oil price pretty well as much happens before QE was even a twinkle in Mario Draghi’s eye. Also I note that if we look back to January 2015 Mario Draghi agreed with me.

Looking ahead, recent declines in oil prices have strengthened the basis for the economic recovery to gain momentum. Lower oil prices should support households’ real disposable income and corporate profitability.

The Euro exchange-rate

This is awkward because if we look back we see that after the QE announcement the effective or trade-weighted Euro exchange-rate fell to 92.2 late last January and it is now ahem, 92.2! Okay so we return to my theory that exchange-rates fall in anticipation of QE and we see that the Euro effective exchange-rate was falling anyway in 2014 but from mid-December fell from a convenient 100 to 92.2.

There are issues with this as of course the exchange-rate is falling in anticipation of monetary easing and cannot have known – in spite of the hedge fund briefings – exactly what was going to happen. For example the ECB could have dipped its foot rather than its toe into the world of negative interest-rates.

Inflation

Yesterday provided yet another disappointment for the ECB as the consumer inflation data was released.

Euro area annual inflation is expected to be 0.2% in December 2015, stable compared to November 2015,

This compares to the objective stated by Peter Praet of the Executive Board only this morning.

You may label that ECB policy a success if inflation, the rise in the cost of living, stays below, but close to, 2% over the medium term. That is our mandate.

Consequently Peter thinks this about the state of play.

I admit that our policy has not yet been successful enough: inflation rates in Europe have been at the very low level of almost 0% for quite some time now.

Accordingly he hints at “More,More,More”

That is why we are continuing to take the necessary measures to drive inflation up to 2% over the medium term.

Here is where I completely depart from the ECB view and indeed much of the analysis you will find in the media and elsewhere. I welcome the “failure” of the ECB in this area as lower consumer inflation driven by the falls in the price of commodities and oil has pushed real wages higher in the Euro area. This has boosted consumption as I highlighted earlier by looking at retail sales data. Once you think of it like that the ECB has in fact acted against the interests of ordinary consumers and workers by trying to drive inflation higher and make things more expensive. Accordingly its failure in this regard has boosted the economy in 2015 and looks likely to do so further in early 2016.

If we move to the exchange-rate impact which will have been the main driver here we see that it will have had a very mixed and potentially adverse overall impact. In simple terms a lower effective exchange rate is expected to generate more net exports although in the credit crunch era less so than in the past. But against that we have the way that it has raised material costs (or more specifically they have fallen by less than otherwise). Also we have the way that it has offset the beneficial falls in consumer inflation and rise in real wages.

Comment

This morning Peter Praet has tried to muddy the waters on the issue of QE.

If the ECB had not taken the measures that it did, we would be in a depression; I’m convinced of that. And a depression would be much worse than what we are experiencing today and worse than what we went through over the past decade.

He is deliberately obfuscating by combining all the ECB monetary easing measures rather than just discussing the QE ” €1.5 trillion (i.e. €1,500,000,000,000),” . Although I can agree with him on this.

The ECB’s policy undoubtedly has unintended consequences.

My view is that the “unintended” here has been the beneficial oil price fall which completely changed changed late 2014 and 2015 and will run into early 2016. But Peter’s QE policies have offset that to some extent in a failure which has attempted to undermine an economic success.

Another way of looking at this is we move from the “deflation” mantra of these times -although they usually fail to understand they mean disinflation – is that there is a clear sign of inflation. Today we find it in the case of where deploying €1,500,000,000,000 has so little effect. We have moved from billions to trillions as we wonder whether quadrillions will be along soon?

We also have an addition to my financial lexicon for these times.

In some countries, there is a risk that real estate prices or some equity and other financial markets are increasing in a way that is too rapid or artificial. We are keeping a close watch on that.

Close watch means do nothing.

Oh and I did not realise that Peter and the ECB have imported tactics from England’s Rugby World Cup campaign.

There is no plan B, there is only one plan.