Commodities: Slip Sliding. China’s latest economic indicators showed some strength. However, that strength hasn’t shown up in commodity prices. China’s industrial production and real retail sales rose 6.3% and 9.3% y/y through August (Fig. 1). While those growth rates were a bit better than expected, they remain close to recent cyclical lows in both series.
The CRB raw industrials spot price index rebounded earlier this year from last year’s plunge (Fig. 2). It has been meandering sideways since the spring. The index includes the price of copper, which is highly correlated with the growth rate in China’s industrial production (Fig. 3). Both remain in their downward trends of the past few years.
Like the CRB index, the price of a barrel of Brent crude oil recovered earlier this year after plunging by 76% from mid-2014 through early 2016 (Fig. 4). It has been hovering between $42 and $52 since mid-April.
In many ways, the price of oil is the tail that’s wagging the dog. It is highly inversely correlated with the trade-weighted dollar (Fig. 5). Causality probably runs both ways, so a weaker (stronger) oil price seems to put upward (downward) pressure on the dollar. That may be because oil exporters have fewer (more) dollars to convert to other currencies when the price is weak (strong).
Of course, there is a feedback effect from the dollar to oil and other commodity prices. The CRB raw industrials spot price index, which doesn’t include oil, tends to strengthen (weaken) when the dollar is weak (strong) (Fig. 6).
For now, Debbie and I foresee the choppy sideways actions of the dollar, oil prices, and other industrial commodity prices continuing through the middle of next year. The Fed’s process of gradually normalizing interest rates is turning out to be very gradual, which should keep the dollar from moving higher given that it is up 19% from its low on July 1, 2014. On Monday, Fed Governor Lael Brainard said that the Fed/US econometric model shows that such an increase is equivalent to a 200bps hike in the federal funds rate. In other words, the foreign exchange market has already done much of the Fed’s work.
Nevertheless, if the oil market’s fundamentals push the price of oil back down again, the dollar could move still higher and depress other commodity prices. So let’s review the latest developments in oil’s supply and demand:
(1) Inventories. The combination of weak demand and increased OPEC output pushed oil inventories in developed nations to a record 3.1 billion barrels in July. Yesterday, the International Energy Agency (IEA) predicted that the surplus in global oil markets will last for longer than previously estimated. So world oil stockpiles will continue to rise through 2017, resulting in a fourth consecutive year of oversupply. Just last month, the IEA predicted the market would return to equilibrium this year.
(2) Supply. The IEA’s revised estimates of the supply/demand oil balance on Tuesday followed a similar revision by OPEC on Monday. The 9/12 WSJ reported: “In its closely watched monthly report on market conditions, OPEC said non-OPEC members like the U.S., Russia and Norway will produce about 190,000 barrels a day more than expected in 2016, a sign that production outside the cartel has remained resilient despite low prices. By 2017, the cartel’s data suggests that oil supplies will outstrip demand by an average of about 760,000 barrels a day, over three times higher than OPEC predictions made just last month.”
(3) Strategic petroleum reserve. In August, the US Department of Energy released its “Long-Term Strategic Review of the U.S. Strategic Petroleum Reserve.” It said that instead of the nearly 700 million barrels the US currently stockpiles, an SPR around 530-600 million barrels would be more appropriate. Much has changed since the SPR was set up in the aftermath of the 1973 oil embargo. The US is one of the largest oil producers in the world, so energy security isn’t as important.
(4) US production. That all seems very bearish for oil prices. However, keep in mind that lower oil prices probably will continue to reduce oil production in the US. Arguably, the new swing producer in the oil market is now the US rather than Saudi Arabia. The weekly US oil rig count seems to be a very good 18-month leading indicator of weekly oil field production in the US (Fig. 7).
Production is down 11.5% from a recent high of 9.6mbd during the week of July 3, 2015 to 8.5mbd during the week of September 2, 2016. The rig count has rebounded slightly in recent weeks, but remains down sharply from the peak of late 2015. The implied drop in US oil production could provide some bullish support to offset the bearish factors highlighted in the IEA and OPEC reports.
Meanwhile, US gasoline demand over the past 52 weeks through the 9/2 week rose to 9.3mbd, matching the previous record high during 2007 (Fig. 8).
On the other hand, Apache found lots more oil last week. The 9/7 WSJ reported: “Apache Corp. said it has discovered the equivalent of at least two billion barrels of oil in a new West Texas field that has the promise to become one of the biggest energy finds of the past decade. The discovery, which Apache is calling ‘Alpine High,’ is in an area near the Davis Mountains that had been overlooked by geologists and engineers, who believed it would be a poor fit for hydraulic fracturing.”
The Fed: Role Call. FRB-SL President James Bullard participated in a rather jovial interview with the WSJ’s Hilsenrath at Jackson Hole on 8/27. Bullard joked that a couple of catchphrases that Hilsenrath had come up with would be great on a T-shirt: “hike today and then delay” and “no hike today and then no more delay.” In all seriousness, that was Bullard’s way of acknowledging that there might be a means to get the FOMC’s voters to agree to a rate hike in September even though they might be divided. In his words: “You would trade off. You would say, OK, we could hike today, but then we’ll not plan to do anything in the future. That would be … one way to go about a consensus.”
Based on our reading of the 10 FOMC voting members’ latest comments, four are doves, three are hawks, and three are undecided. That should make for a vigorous debate at the next FOMC meeting on September 20 and 21. While each FOMC member gets a vote, the final decision isn’t really based on majority rules. Rather, as Bullard suggested, there’s a give-and-take between members to reach a consensus, with the possible exception of a dissenter or two. And it’s exactly the lack of a clear consensus heading into the September meeting that suggests that the Fed’s next rate hike will likely be postponed. Even if the FOMC decides to pull the trigger in September, the path of subsequent increases will likely be very shallow. Consider the following quick roundup of the FOMC’s voting members’ recent comments:
(1) Send in the doves. Fed Governor Lael Brainard delivered a very dovish speech on Monday, as we discussed yesterday. Oddly, her appearance hadn’t been scheduled until last Thursday, reported the 9/9 WSJ. Some conspiracy theorists surmised that Brainard was sent in to calm markets. Her speech served as the last word ahead of the Fed’s quiet period leading up to the September 20-21 FOMC meeting. And it followed some hawkish commentary from other Fed officials, as discussed below.
Separately, but with the same tone, Fed Governor Daniel Tarullo participated in a mid-morning interview with CNBC on Friday, 9/9. During the interview, he agreed with those who’ve characterized him as being in the “show me” camp. He was referring to the overall picture of data and a sense of the “momentum of the economy.” He added: “We’re not running a hot economy.” And he suggested that he’s looking for “more tangible evidence of inflation” and “maximum employment” before “removing accommodation.” In August, Fed Governor Jerome Powell similarly told the FT: “With inflation below target, I think we can be patient.”
So that makes for three seemingly obvious doves. But wait, there’s one more to make four for now. And that’s FRB-NY President William Dudley, who said in an 8/26 CNBC interview: “From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago.”
(2) Hawk attack. FRB-BOS President Eric Rosengren gave a very hawkish speech a few hours before Tarullo’s dovish interview on Friday, saying: “My personal view, based on data that we have received to date, is that a reasonable case can be made for continuing to pursue a gradual normalization of monetary policy.” Rosengren observed that global risks don’t seem to present an “outsized” risk to the US economy. Interestingly, one of Brainard’s five main points seemed to be a direct counter to that point. Even though Rosengren noted that there were “some conflicting signals in the economic data,” he focused more on the risks of “waiting too long to tighten.”
Another hawk is FRB-CLE President Loretta Mester. In an 8/26 CNBC interview at Jackson Hole, she emphasized that the economy is on a “good track.” She thinks 3% growth in the second half of the year is not unreasonable with employment solid and inflation heading in the right direction. That all adds up to “starting to move interest rates up.” Of course, FRB-KC President Esther George makes for three confirmed hawks. She’s the only FOMC member who dissented on the decision to do nothing during the July 27-28, April 26-27, and March 15-16 FOMC meetings. On 8/25, she said again that rates should go higher, according to CNBC.
(3) On the fence. It’s hard to figure out exactly where Fed Governor Stanley Fischer stands. But most observers interpreted his 8/30 interview on Bloomberg TV as more hawkish than dovish. “I don’t think you can say ‘one and done’ and that’s it,” he said. On the other hand, implying that incoming data will determine the pace of hikes, he said: “The work of the central bank is never done.” While he mentioned concerns around productivity growth, he suggested that it should pick up.
Similarly, in his interview with the WSJ, Bullard didn’t make any declarative statements about where he stands. On the one hand, he said that he doesn’t agree with the perspective that the “dollar strength is still playing in and dragging down growth.” Nevertheless, he suggested that he would like to see above-trend growth in the second half of the year before aggressively raising rates. Of course, Bullard has been one of the most difficult Fed officials to pin down since he decided not to provide any “dots” for the Fed’s latest dot plot forecast. Just days before the interview, he suggested in an 8/25 statement that a very shallow path of rate increases might be the appropriate course over the next couple of years.
The Fed official with the most important voice of all, Fed Chair Janet Yellen, historically has been very dovish. But it seems she can be swayed by the chorus of others. Yellen’s 8/26 speech seemed to make a stronger case for interest-rate increases. Still, she hedged by presenting a “fan chart” showing the wide range of projections for the federal funds rate that are possible through 2018. Our hunch is that she will use Brainard’s five-reasons-for-doing-nothing to make her case for doing nothing, at least at the next meeting, as we discussed yesterday.