Discoveries of new oil reserves have dropped to their lowest level for more than 60 years, pointing to potential supply shortages in the next decade.
Oil explorers found 2.8bn barrels of crude and related liquids last year, according to IHS, a consultancy. This is the lowest annual volume recorded since 1954, reflecting a slowdown in exploration activity as hard-pressed oil companies seek to conserve cash.
Most of the new reserves that have been found are offshore in deep water, where oilfields take an of average seven years to bring into production, so the declining rate of exploration success points to reduced supplies from the mid-2020s.
The dwindling rate of discoveries does not mean that the world is running out of oil; in recent years most of the increase in global production has come from existing fields, not new finds, according to Wood Mackenzie, another consultancy. Additionally, there has been a predominance of gas, rather than oil, in recent finds.
But if the rate of oil discoveries does not improve, it will create a shortfall in global supplies of about 4.5m barrels per day by 2035, Wood Mackenzie said.
That could mean higher oil prices, and make the world more reliant on onshore oilfields where the resource base is already known, such as US shale.
Paal Kibsgaard, chief executive of Schlumberger, the world’s largest oil services company, told analysts last month: “The magnitude of the E&P [exploration and production] investment cuts are now so severe that it can only accelerate production decline and the consequent upward movement in [the] oil price.”
The slump in oil and gas prices since the summer of 2014 has forced deep cuts in spending across the industry. Exploration has been particularly vulnerable because it does not offer a short-term pay-off.
The industry’s spending on exploring and appraising new reserves will fall from $95bn in 2014 to an expected $41bn this year, and is likely to drop again next year, according to Wood Mackenzie.
In spite of the decline in activity, the total combined volume of oil and gas discovered last year rose slightly, but the proportion of oil dropped from about 35 per cent in 2014 to about 23 per cent in 2015.
The two largest finds of last year, Eni’s Zohr field off the coast of Egypt, and Kosmos Energy’s Greater Tortue off Mauritania and Senegal, both hold gas.
Bob Fryklund of IHS said: “We’ve hunted a lot for oil over the years, and now the areas that are oil-prone are fewer than the areas that are gas-prone.”
Claudio Descalzi, chief executive of Eni, in March described exploration as the “foundation of our growth”, but the company is unusual among large international oil groups.
In 2008-15 Eni’s oil and gas discoveries, mostly gas, were 2.4 times its production, compared to just 0.3 times on average for other large European and US oil companies.
Some in the industry argue that there are plenty of large new oilfields waiting to be discovered.
Jonathan Faiman, chairman of Neos, which collects and analyses geological data for oil companies and governments, said that the slump in exploration budgets created “huge opportunities” for those that were brave enough to invest during the downturn in the cycle.
He added: “We are confident that large onshore fields with low lifting costs have yet to be identified.”
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Italian-German 10-year yield spread at widest in two months
GDP data could signal if ECB’s QE is working: Cantor’s Callan
Government bonds from the euro region’s so-called peripheral nations may further underperform German securities with a banking crisis in Italy and political gridlock in Spain far from being resolved.
While euro-area sovereign bonds are supported by the European Central Bank’s 80 billion euros ($91 billion) a month asset-purchase program, domestic solvency worries are back in focus. Even as Italian 10-year bonds were little changed this week, the yield spread versus similar-maturity German debt widened to the most in more than two months Friday as Italy’s troubled banking sector threatened to hurt its still weak economy.
The gap between Spanish and German 10-year bond yields widened to the most in a month as Spain heads to its second election in six months after missing a deadline to form a government in May. Falling oil prices and faltering equity markets this week prompted investors to seek the relative safety of German debt, the region’s benchmark sovereign securities.
“We now have the Spanish general election back on the table,” said Owen Callan, a Dublin-based fixed-income strategist at Cantor Fitzgerald LP. “So political risk in the peripherals will start to become an issue again. We still have issues around the Italian banking sector in the background. That’s going to bring a bit of volatility into the peripheral bonds.”
Spread Widens
Italy’s 10-year bond yields were at 1.49 percent as of the 5 p.m. close Friday in London. The price of the 2 percent security due in December 2025 was 104.54 percent of face value. The yield on German 10-year bunds fell 13 basis points, or 0.13 percentage point, in the week to 0.14 percent, its biggest decline since Jan. 29.
That left the yield spread between the securities at 1.35 percentage points, after reaching 1.37 percentage points, the most since Feb. 26. The gap between Spanish and German 10-year yields was at 1.45 percentage point, having earlier touched 1.47 percentage points, its highest since April 11.
Cantor Fitzgerald’s Callan said gross domestic product data due on May 13 may offer signs of a sustained recovery.
The region’s economy expanded 0.6 percent in the first quarter, according to the median forecast of analysts in a Bloomberg survey.
Growth data “tells you what’s happening in the real economy,” Callan said. “If we do have a more positive outlook, maybe that suggests the ECB’s measures are working. You could say that should embolden them to continue to go further with it.”
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Regulators are scrutinising the finances of co-operative lenders that fund the cab trade in New York and some other US cities, as the disruption caused by Uber spreads beyond the taxi stand.
Documents filed in recent days show borrower delinquencies at the $2bn Melrose Credit Union more than doubled in the first three months of the year and more than tripled at the smaller taxi financier Lomto.
Taxi drivers and fleet owners in New York and other cities including Chicago are required to have licences, known as medallions, to pick up passengers.
As authorities controlled how many of the medallions they issued, the value of this right to be a part of the lucrative yellow cab trade swelled.
Taxi operators needed to borrow to afford the licences and as medallion prices kept rising and fares kept rolling in, lenders were only too willing to supply the funds. By 2013, medallions in New York were changing hands for more than $1m apiece.
“There was a bubble, no question about it,” says Alexander Twerdahl, analyst at Sandler O’Neill.
No longer. Intensifying competition on the streets from ride-hailing upstarts such as Uber and Lyft has made taxi borrowers struggle to keep up with their medallion loan repayments.
As well as facing mounting losses from defaults, lenders are being further squeezed as the value of the collateral tumbles. Some medallions are now for sale for as little as $500,000.
The difficulties are a reminder of how quickly fortunes can turn in finance, even in supposedly low-risk assets.
The biggest impact has been on credit unions — co-operatives that take deposits and make loans.
Tim Segerson, deputy director of examination at the National Credit Union Administration, told the Financial Times the watchdog was “closely monitoring the situation”.
He said a “very small number” of institutions had “large portfolios of these loans”.
“Historically they have focused more on loan production than on risk mitigation,” he added. “Part of our expectation is they refocus their efforts on minimising any potential losses that may come out of the taxi portfolio.”
A clear sign of stress emerged last year when financial regulators at New York state’s Department of Financial Services took possession of Montauk Credit Union.
The co-operative was crippled by troublesome Chicago medallion lending. Montauk merged with Bethpage Federal Credit Union about a month ago.
People familiar with the matter said Montauk had been especially aggressive in taxis and was the least well capitalised of credit unions with big exposures.
It is far from the only business with a sizeable cab loan portfolio, however.
The credit unions Melrose and Lomto, together with other groups including an association of medallion owners, are taking on the New York authorities in the courts.
“Companies like Uber have been able to quickly construct parallel unlicensed taxi networks,” the plaintiffs complain, “without many of the significant regulatory burdens and expenses that medallion taxicabs are subject to”.
Reportable delinquent loans at Melrose shot up from $155m at the end of December to $371m at the end of March. They stood at just $5.7m a year ago.
Melrose’s recent financial filing did not disclose the extent to which soured medallion loans were to blame for its deteriorating credit quality. However, a lawsuit filed last November gives a sense of how much the taxi exposure is hurting the business.
The 94-year-old institution, based in Queens, New York, has total assets of about $1.93bn. As of last June, the suit said, Melrose had an interest in about 3,100 taxicab medallions as collateral for loans worth about $1.56bn.
The suit said Melrose had hundreds of medallion loans maturing between last November and February. “In December alone, Melrose has 190 medallion loans maturing with almost $83m in balloon payments becoming due.”
Lomto, founded in 1936 by a group of New York medallion owners, is also exposed. Delinquencies at the credit union, also based in Queens, jumped from $6.4m to $22.4m during the first quarter. A year ago they were just $2.8m.
Melrose and Lomto did not respond to requests for comment.
Several banks large and small have also engaged in taxi lending.
Provisions for credit losses at Capital One, the eighth-biggest listed US lender, have leapt $168m over the past year to $228m as of March 31.
Capital One would not say how much of the increase was as a result of medallions, but Richard Fairbank, founder, singled out its taxi portfolio — along with energy — as an area in which credit quality had deteriorated.
Signature Bank, which has a market capitalisation of $7.2bn, is also feeling the pinch.
In the first three months of 2016, troublesome loans on the “watch list” of New York-based Signature rose by $53m to $403m, mainly because of concerns about taxi loans.
“I would anticipate things to continue to get worse in that portfolio for the next couple of quarters,” Eric Howell, executive vice-president of corporate and business development at Signature, told investors.
“We’ll probably see an uptick in charge-offs over the next few quarters, and then we should see it start to stabilise.”
Several analysts of the listed banks said the damage was containable. A Morgan Stanley report in March said Signature’s exposure to taxis was equivalent to 3.4 per cent of its total loans.
Ken Zerbe, an analyst, estimated the bank’s earnings per share could drop as much as 10 per cent in a “worst-case” scenario for taxi credit losses, but added “the more likely earnings impact is far less”.
Investors will get more insight into troubled cab loans when the publicly quoted specialist Medallion Financial reports its quarterly results this week. Its market capitalisation has fallen from a high of $400m in 2013 to $180m.
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Battle is over `contingency measures’ demanded by IMF
Euro-area finance ministers gather on Monday in Brussels
Greece returns to center stage on Monday when aid deliberations by its international creditors will signal whether the country faces a renewed period of political drift or wins some economic breathing space after six years of turbulence.
The euro area and the International Monetary Fund will assess whether Greek Prime Minister Alexis Tsipras has made enough budget-tightening commitments to gain another aid disbursement. At issue is an IMF demand for fiscal “contingency measures” worth about 3.5 billion euros ($4 billion) in case Greece strays off budgetary course.
Such a package, equal to 2 percent of Greece’s gross domestic product, is politically thorny for a premier who promised voters he’d oppose any extra austerity and who governs with a three-seat parliamentary majority. Should the IMF give the Greek government insufficient wiggle room at the meeting with euro-area finance ministers in Brussels, Tsipras could end up calling snap elections or a referendum — both of which featured last year when Greece came close to a euro exit.
“The nature of the contingency package could determine the government’s fate, as it would be very difficult to secure the required parliamentary majority for detailed measures,” Wolfango Piccoli, an analyst at Teneo Intelligence in London, said in a May 6 report. “The risk of snap polls could increase significantly if the lenders decide to play hardball.”
The contingency measures come on top of a 5.4 billion-euro belt-tightening package needed to secure further aid from the euro area and the IMF. Tsipras’s government managed to push through parliament a set of pension and income tax reforms early Monday with a majority of 153 votes in Greece’s 300-seat chamber.
Greek Recession
The wrangling over Greece’s progress in meeting the terms of last year’s 86 billion-euro rescue is reminiscent of the political struggles that accompanied the country’s two previous bailouts since 2010, leaving the nagging question of whether the country can get off life support and stay in the European single currency.
The Greek economy has slipped back into recession (after slight growth in 2014 snapped six years of contraction), unemployment has stayed stubbornly high at about 25 percent and public support in the country for the 19-nation euro has weakened.
With the current budget review of Greece six months behind schedule, Tsipras is running out of time to qualify for a fresh aid disbursement before Greek bonds held by the European Central Bank come due in July.
After riding to power in January 2015 on an anti-austerity wave before flip-flopping over fiscal tightening to win the latest bailout, Tsipras blames the current impasse on the IMF and has sympathy from some European creditors.
Debt Burden
The need for contingency measures — additional austerity steps if budget requirements are missed — stems from an IMF disagreement with the euro-area. While euro officials consider Greece’s existing commitments are adequate to reach a targeted budget surplus before interest payments of 3.5 percent of GDP in 2018, the IMF projects that current Greek measures will produce an excess of just 1.5 percent.
IMF Managing Director Christine Lagarde wrote in a letter to Eurogroup members last week, saying that absent debt relief, Athens would need to legislate the contingency measures before the fund would move forward. Greek Finance Minister Euclid Tsakalotos wrote in his own letter to the group that voting on those steps isn’t constitutionally viable.
On May 7, Greece’s European creditors circulated a draft memorandum, which will be discussed during the Monday meeting, that included those additional austerity measures, according to a copy of the document obtained by Bloomberg News. The proposal weighs a trigger that would cut certain expenditures and increase tax revenue if budget targets are missed.
Athens submitted a last-minute amendment to parliament on May 6, targeting 200 million euros in revenue by lowering the income-tax free threshold to 8,363 euros from 9,100 euros. The move is meant to comply with Greece’s overhaul of its core economic package and comes a step closer to IMF demands.
Because Germany insists that the Washington-based IMF remain part of the Greek rescue, Europe has no room to set aside the divisive question of contingency measures.
An incentive for Tsipras’s Syriza party and its junior coalition partner, the nationalist Independent Greeks, to swallow the IMF’s bitter pill is a promise by the creditors that any deal to release more aid will trigger talks about debt relief in the form of lower interest rates and longer maturities on rescue loans.
That carrot has been on the table since 2012 and didn’t prevent the Greek government of former Prime Minister Antonis Samaras, an ally of German Chancellor Angela Merkel, from running into IMF intransigence on fiscal measures in late 2014 and being ushered out of office within two months.
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China is doubling down on efforts to keep unprofitable factories afloat despite for years pledging to curb excess capacity, adding to a glut of basic materials flooding the global economy.
The country’s overproduction of steel, aluminum, diesel and other industrial goods has driven down prices and crippled competitors, leading to thousands of lost jobs in the U.S. and elsewhere.
China’s continuing aid for unneeded factories is triggering a sharp rise in trade disputes and protectionist sentiment, especially in the U.S., where trade has emerged as one of the pivotal issues in the U.S. presidential election.
According to a Wall Street Journal analysis of Chinese public companies, Chinese government support includes billions of dollars in cash assistnace, subsidized electricity and other benefits to companies. Recipients include steelmakers, coal miners, solar-panel manufacturers, and other producers of other goods including copper and chemicals.
One beneficiary, Aluminum Corp. o f China, or Chalco, said in October one of its units would shut down a roughly 500,000-ton-per-year smelter in the far-western Gansu region as it struggled to make profits. Executives prepped for thousands of layoffs.
Then Gansu officials slashed the plant’s electricity bill by 30%, employees say, and the factory was saved. Although a portion of capacity was taken offline, most is operational.
“We’re in full production now with 380,000 tons of capacity,” said Fei Zhongchang, a company sales manager. Chalco’s press office and local government officials didn’t respond to requests for further comment.
In Europe, workers have joined protests against Chinese steel imports. Australia has investigated dumping of products including solar panels and steel and India has raised import taxes on steel after a surge of cheap Chinese goods.
The U.S. launched seven new investigations into alleged dumping or government subsidies involving Chinese goods in the first three months of this year, more than the same period of any other year dating back to at least 2003, government data show.
Earlier this year, the U.S. Commerce Department slapped preliminary import duties of 266% on imported Chinese cold-rolled steel. The decision came after U.S. Steel Corp. lost $1.5 billion last year, closed its last blast furnace in the South and laid off thousands of workers, blaming China.
Late last month , U.S. Steel filed a trade complaint against China at the International Trade Commission, alleging price fixing, trans-shipment via third countries to avoid duties and cyber-espionage to loot technology off U.S. Steel computers. China’s Commerce Ministry has urged U.S. authorities to reject the complaint, and said allegations of intellectual property infringement “are completely without factual basis.”
China says it isn’t guilty of dumping—or selling a product at a loss in order to gain market share—and calls U.S. and EU measures and investigations forms of protectionism. It says it has mothballed factories and intends to cut more, with plans to lay off up to 1.8 million steel and coal workers.
Officials say it is natural for complaints against China to increase as the country takes on a large share of global trade.
“As the largest trader in goods, it’s quite understandable for us to have so many” complaints, China’s Commerce Minister Gao Hucheng said recently. “We need to take it as it comes and live with it.”
One way of tracking China’s support is by looking at subsidies reported in corporate filings on the country’s two main stock exchanges in Shanghai and Shenzhen.
According to a Journal analysis of nearly 3,000 domestic-listed Chinese companies in 2015, reported government aid rose to more than 118 billion yuan, or more than $18 billion, last year compared with about 92 billion yuan in 2014.
Reported subsidies have risen roughly 50% since 2013, based on figures from Shanghai data provider Wind Information Co. Under Chinese accounting standards, such aid can be cash or other perks like subsidized power or land, but doesn’t include some other support, such as capital injections from the government as an equity shareholder.
Recipients include an ethanol producer that said it was promised as much as 40 million yuan ($6.1 million) in subsidies in the first three months this year because of “grave operating circumstances.”
A producer of titanium dioxide—which is used in products such as paint and sunscreen—won about 28 million yuan ($4.3 million) in cash assistance as it seeks to expand in the North America and elsewhere.
Another company, Yunnan Aluminium Co. , obtained nearly 500 million yuan ($77 million) in subsidies since late 2015, securities filings show. In the first half of 2015, the company says its production of alumina—the starting material for smelting aluminum metal—jumped 40%, even as revenue sank amid weakening prices.
Company representatives didn’t respond to requests for comment. An official at the provincial Department of Finance, which administered much of the cash aid, said it acted to protect Yunnan Aluminium’s 10,000 jobs.
“The government’s aim is to help maintain social stability,” the official said.
Other countries, including the U.S., offer substantial support for struggling industries.
Experts cite differences in China, which they say is less open about its use of subsidies and more inclined to use them to promote exports. China has repeatedly said it would shutter unneeded factories, without following through.
The need for capacity cuts in China has long been apparent. More than 40% of its major steel companies were losing money in the first half of 2015, according to the China Iron and Steel Association.
China’s Ministry of Industry and Information Technology, which oversees the steel industry, told the Journal in 2014 that authorities were already “in the process of implementing” capacity reductions.
Since then, Chinese crude steel production has fallen 2% year-on-year in 2015 to about 804 million metric tons. But industry experts in China, the U.S. and Europe say a further 200 million metric tons of capacity—or about 25% of China’s production—needs to be cut to restore market balance. China’s steel exports jumped around 20% last year to 112 million metric tons, according to customs data.
A 63-page “investigation initiation checklist,” filed last year by U.S. Steel Corp., Nucor Corp. and the United Steelworkers union to demand import tariffs on rolled steel, found 44 separate subsidy programs, including seven that give Chinese steelmakers cheap or free land, iron ore, coal, and power; eight that offer discount loans; 15 tax breaks; and 11 programs that give companies money directly.
Some of the programs date back years, but others were active in the past 12 months, including subsidized export loans, the document showed.
“It’s the whole range of practices that keep these zombie companies alive,” said Roger Schagrin, a lawyer for U.S. steelmakers.
At the time, a spokesman for China’s Commerce Ministry said restrictions on Chinese steel would not solve the global overcapacity problem, and encouraged Chinese steel companies to defend their rights.
Other Chinese products rattling markets include diesel fuel, with Chinese exports rising nearly 80% in 2015 over 2014, according to customs data. China has loosened restrictions to let private refiners export fuel for the first time, given weak domestic demand.
While U.S. energy companies shed staff, China’s by and large haven’t. Refining giant China Petroleum & Chemical Corp. , whose net profit fell by 30% in 2015, told the Journal no employees have been laid off since late 2014 when oil prices began to fall, and that it had “no plan for any future layoffs.” The company, also known as Sinopec, employs about 351,000 people.
China’s aluminum production, meanwhile, rose to 32 million tons in 2015, double the level in 2005. Exports soared to 6.7 million tons from 2.6 million during the same period, helping push global prices down 40% in the past five years. The number of smelters in the U.S. has fallen to four from 23 in 2000, destroying thousands of jobs.
Tensions over lost jobs reflect wider frustrations that China hasn’t lived up to all the promises it made when it joined the World Trade Organization in 2001.
According to data collected by the WTO, China accounted for around 25% of all anti-dumping measures reported between 1995 and 2014, more than any other nation. The U.S. was the target in about 5% of measures, the data show.
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China reported a decline in exports and imports in April, a reversal of figures the previous month that indicated a tentative revival in both external and domestic demand.
Data published on Sunday by the General Administration of Customs showed that exports fell 1.8 per cent year on year in US dollar terms. That exceeded a consensus estimate by Trading Economics of a 0.1 per cent drop, and came after an 11.5 per cent surge in March.
Imports in April slid 10.9 per cent from the same month last year, more than double the consensus forecast for a 5 per cent drop and deepening the previous month’s 7.6 per cent decline.
China had a trade surplus in April of $46bn, versus $34bn a year earlier.
First-quarter gross domestic product figures last month suggested the economy was broadly stabilising after a slowdown in the second half of last year, growing at an annual rate of 6.7 per cent in January to the end of March.
However, there are concerns that the improvement in China’s outlook is primarily to do with short-term stimulus measures as Beijing attempts to shift away from heavy industry and manufacturing for export towards a service-based economy fuelled by domestic consumption.
The International Monetary Fund warned last week that Asian countries were expected to suffer as a result of China’s rebalancing, and in particular that Chinese demand for imports from South Korea and Taiwan would drop.
China’s rebalancing accounted for a “big chunk” of China’s import slowdown in the past decade, the IMF said, attributing the slowdown to the reduction in investment and in exports, two sectors that intensively use imported intermediate goods.
“Component imports are soft, suggesting a dim outlook for manufacturing output and exports in the near term,” wrote Moody Analytics in a note. Exports of goods processed or assembled in China with foreign inputs fell 13.3 per cent year on year.
As the wages of its assembly line workers slowly rise, China’s economy is suffering the relocation of garment and technology factories to neighbouring Vietnam and Bangladesh.
Foreign-exchange reserves data, released on Saturday, showed that China’s reserves rose in dollar terms for the second month in a row, by $7.1bn to $3.2tn.
However, the increase was driven by a softening US dollar, which pushed up the value of China’s euro- and yen-denominated assets and thus the value of the overall pot in dollar terms.
Excluding the valuation effect, money is still flowing out of China, though at a more moderate pace, with a net forex outflow of $13.3bn in April, less than March’s $37bn, according to estimates from researchers at China International Capital Corporation.
The narrowing of foreign reserve outflows suggests the central bank is confident enough in the strength of the Chinese currency to ease off its intervention to support the renminbi. The renminbi has risen 14.8 per cent against the dollar since hitting a trough for the year on January 8.
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Via the WSJ:
By Ira Iosebashvili,
Chelsey Dulaney and
Christopher Whittall
May 8, 2016 5:30 a.m. ET
The powerful rallies that have lifted stocks, crude oil and emerging markets for the past three months have one important thing in common—the falling dollar—and investors are growing anxious that it could prove to be the weak link.
While the dollar is down 4.5% this year and near a one-year low against a basket of currencies, other investments have surged. U.S. crude prices are up 69% from their February lows. Gold was up 16.5% in the first quarter, its best in three decades. And emerging-market stocks, bonds and currencies have enjoyed double-digit gains in 2016.
Analysts at Morgan Stanley measured the correlation between a weak dollar and their own index of investor appetite for riskier assets. They found it near its highest level in 20 years.
The concern is that it is a relationship that could easily go in the opposite direction. The dollar is heavily dependent on perceptions of what the Federal Reserve will do with interest rates, and those perceptions could change quickly. Meanwhile, analysts warn that the fundamentals for oil, emerging-market assets and even many stocks look too weak to support the recent price gains on their own.
“Currency is the most influential factor for markets this year,” said Graham Secker, head of European equity strategy at Morgan Stanley. “If the dollar starts moving higher, global risk appetite will fall.”
On Friday, Labor Department figures showing that U.S. job growth slowed in April kept alive the bet on riskier markets. The data gave the Federal Reserve little reason to raise interest rates soon, economists said.
But traders fret that every new economic report could bring the Fed a step closer to raising rates—a move that would be expected to support to the dollar—if data come in stronger than expected. Higher rates make a currency more attractive to yield-seeking investors.
“I was like ‘phew,’ ” said Paresh Upadhyaya, director of currency strategy at Pioneer Investments, after the weaker-than-expected jobs numbers were announced on Friday. “I breathed a sigh of relief that this risk rally will continue.”
Mr. Upadhyaya, whose firm manages $249 billion, has shut down his bullish positions on the dollar in recent months in favor of emerging-market currencies, including the Indian rupee, Russian ruble and Argentine peso.
The rally’s next test could come soon. This week brings retail-sales figures and speeches from Fed officials. The following week, the government announces industrial-production numbers.
When the dollar weakens, dollar-denominated commodities tend to appreciate in value, even though many of those markets are heavily oversupplied. Also, emerging-market currencies strengthen, and the foreign-currency debt of those countries becomes cheaper to pay back. Still, many developing economies are struggling with waning demand from China, a major commodity customer, so stocks and other assets could get caught in any dollar updraft.
Morgan Stanley’s Global Risk Demand Index, which measures risk appetite by analyzing moves in markets such as stocks, commodities, and emerging markets, is moving nearly in the opposite direction of dollar strength. The correlation reached negative 86% in early April.
A large negative correlation means risky assets tend to fall when the dollar gains and rise when the dollar falls. As of May 5, the correlation was minus-76%.
The Fed began the year with plans to raise interest rates four times after boosting rates by a quarter of a percentage point in December. But in March, Fed Chairwoman Janet Yellen signaled that the central bank was in no hurry to raise interest rates, citing slower global growth.
Federal-funds futures, used by investors and traders to place bets on central-bank policy, showed Friday that the odds for a rate increase at the Fed’s June meeting were 13%, while the chances of a rate increase at the December meeting were 61%, according to CME Group.
Hedge funds and other speculative investors are now more bearish on the dollar than at any other time since February 2013, data from the CFTC and Scotiabank shows.
The negative view on the dollar has grown as the Fed displayed a more cautious view on raising interest rates, while central banks in Europe and Japan appear reluctant to ease their own monetary policies further. That is bad news for the dollar, which has benefited from expectations that the gap between U.S. and foreign interest rates will continue to widen.
However, that bearish positioning also means any sign the Fed is turning more hawkish could send investors scampering to buy dollars, pushing the U.S. currency sharply higher.
“The market has become complacent,” said Steven Englander, head of G-10 FX strategy at Citigroup Inc. “There’s the risk…the Fed gives a sudden indication that really surprises the market.”
Indeed, some analysts warn that investors may be underestimating the chance of an earlier rate increase. A number of Fed officials have suggested that a move toward higher rates isn’t off the table in the near term. Dallas Fed President Robert Kaplan said he would support a move in June or July if economic data improve. Fed officials in St. Louis and Atlanta have expressed similar thoughts.
A strong dollar doesn’t necessarily spell bad news for all markets. Stock markets in Japan and Europe have suffered this year, in part because of their currencies appreciating against the dollar. That weighs on local exporters.
“I don’t think necessarily a rising dollar is negative for all asset classes,” said Peter Fitzgerald, head of multi assets at Aviva Investors. “A rising dollar would see the yen and the euro weakening, which would be supportive for those markets.”
If there’s one part of being president for which Donald Trump feels uniquely suited, it’s handling the national debt. Since several of his companies have gone through bankruptcy, he has ample experience negotiating with creditors.
“I am the king of debt,” he said on CNBC on Thursday. “I love debt. I love playing with it.”
But would he actually bring those skills to bear as president and force holders of $19 trillion of U.S. Treasury debt to accept less than 100 cents on the dollar, as his comments in that interview at implied? Almost certainly not.
That debt is the lubricant of the global financial system, so default would cause a financial panic of epic proportions. Moreover, as Mr. Trump seems to realize, the U.S. is not like a hotel. It can borrow as much as it likes.
But there’s another way he might try to save money on the debt: by making it a consideration for the Federal Reserve as it sets interest rates. It’s not unprecedented; but the practice would impinge on Fed independence in a way not seen since the 1960s.
Mr. Trump’s policy pronouncements aren’t known for their consistency. He first said during a debate last fall that his experience in bankruptcy qualified him for dealing with the debt. Then earlier this year he said he’d repay that debt in eight years. On CNBC on Thursday, he once again boasted how “I would borrow, knowing that if the economy crashed, you could make a deal.”
When pressed, though, he said a country is different and he didn’t mean to renegotiate the U.S. debt, only to “refinance” existing debt or repurchase it at a discount, “depending on where interest rates are.” Of course, refinancing debt saves money only when rates go down, which raises the question of what the Fed should do with rates.
Mr. Trump wants rates to remain low to prevent the dollar from appreciating, which would bring “major problems.” He added the caveat, though, that if “inflation starts coming in…you have to go up and you have to slow things down.”
But another consideration, he noted, was the national debt: “What do we do with all of the money that we owe everybody when rates go up and now all of a sudden we have to borrow at two points more? One point more, even, is devastating. It has to be handled very, very carefully.”
For the Fed to base interest-rate decisions on the national debt would blur the lines between monetary and fiscal policy. It’s heresy by today’s standards, but not unprecedented. From the 1940s through the 1960s, the Fed routinely adjusted its actions to help the Treasury, eventually allowing inflation to take off.
From 1942 to 1951, the Fed maintained a ceiling on Treasury yields to make it easier for the Treasury to borrow. William McChesney Martin, chairman from 1951 to 1970, often bent to administration demands.
As Alan Meltzer details in his “History of the Federal Reserve,” Mr. Martin would justify such cooperation by saying the Fed was independent within the government, not of the government. At the request of John F. Kennedy’s administration he bought long-term bonds to boost investment. Pressured by Lyndon B. Johnson to support the Great Society and Vietnam War and wanting to be part of his team, Mr. Martin was slow to raise interest rates as the resulting budget deficits fueled inflation.
The modern era of presidential deference to the Fed began in the 1980s. Ronald Reagan reappointed Paul Volcker, a Democrat, because he shared his anti-inflationary zeal. Though Mr. Reagan’s advisers eased Mr. Volcker out in 1987, his successor, Alan Greenspan, was no more pliable. He went on to acquire such mythical stature that it was successive presidents who bent to his influence, not the other way around. Bill Clinton, a Democrat, reappointed Mr. Greenspan, a Republican, and Barack Obama reappointed Ben Bernanke, also a Republican.
Mr. Trump made it clear he wants a Fed chairman to share his politics. Last year he accused Fed Chairwoman Janet Yellen (incorrectly) of doing President Obama’s bidding. He was more diplomatic Thursday, calling her “very capable,” but she is “not a Republican. When her time is up, I would most likely replace her.”
It may seem discordant to worry about inflation when today it’s too low and serious people think central banks should finance government deficits via “helicopter drops” of money. Nor is it a given that any appointee by Mr. Trump would put inflation at risk to help out his administration.
That said, as Mr. Trump’s positions on trade and immigration demonstrate, much economic orthodoxy has been washed away in this year’s political riptide. It’s not hard to imagine that the autonomy of the Fed could be, as well.
US: Wages Hold Their Ground But Weakness Abound in Employment
Nonfarm employment rose by 160k, falling short of expectations and historical revisions cut 19k from the last two months. The unemployment rate remained unchanged as the participation rate fell to 62.8%. Average hourly earnings met the market expectation with a 0.3% m/m increase in April, though the previous month was revised lower to show a 0.2% monthly gain.
A generally disappointing print in employment is only partially offset by momentum in wages. For the Federal Reserve, stronger wage growth will be welcomed but not in an environment where domestic growth appears to be cooling. All eyes therefore remain on the handoff from a weak Q1 to Q2, with patience acting as the dominant theme.
Nonfarm payrolls increased by 160k in April which was short of the consensus expectation for a 200k increase and closer to TD’s own more pessimistic forecast for the addition of 188k. Making matters worse was a set of downward historical revisions that cut a further 19k from the last two months. The unemployment rate remained unchanged at 5.0% as the household survey showed a sizable drop in employment that was matched by an equally disappointing shift lower in the participation rate to 62.8%. Returning to the details of the employment survey, private sector hiring increased by 171k (market: 195k) with disappointing outturns in construction and retail trade. Wage growth was perhaps the only source of relative optimism. Average hourly earnings increased by 0.3% m/m, matching the market consensus, though the previous month was revised a touch lower to 0.2% from 0.3%.
In aggregate, beyond the wage data, this was a very disappointing report. Against a backdrop of sluggish growth through Q1, it is perhaps not that much of a surprise to see employment also slow. For the Federal Reserve, however, signs that wages are firming will be welcomed but not in an environment where growth is slowing. This then shifts the emphasis back to looking at the handoff from Q1 growth to the second quarter. Given the recent tract of patchy data, we would anticipate the Fed retains its cautious tone and remains patient in contemplating its next rate hike. September remains the most likely meeting for the Fed to act.
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One day after assuring Americans he is not running for president “to make things unstable for the country,” the presumptive Republican nominee, Donald J. Trump, said in a television interview Thursday that he might seek to reduce the national debt by persuading creditors to accept something less than full payment.
Asked whether the United States needed to pay its debts in full, or whether he could negotiate a partial repayment, Mr. Trump told the cable network CNBC, “I would borrow, knowing that if the economy crashed, you could make a deal.”
He added, “And if the economy was good, it was good. So, therefore, you can’t lose.”
Such remarks by a major presidential candidate have no modern precedent. The United States government is able to borrow money at very low interest rates because Treasury securities are regarded as a safe investment, and any cracks in investor confidence have a long history of costing American taxpayers a lot of money.
Experts also described Mr. Trump’s vaguely sketched proposal as fanciful, saying there was no reason to think America’s creditors would accept anything less than 100 cents on the dollar, regardless of Mr. Trump’s deal-making prowess.
“No one on the other side would pick up the phone if the secretary of the U.S. Treasury tried to make that call,” said Lou Crandall, chief economist at Wrightson ICAP. “Why should they? They have a contract” requiring payment in full.
Mr. Trump told CNBC that he was concerned about the impact of higher interest rates on the cost of servicing the federal debt. “We’re paying a very low interest rate,” he said. “What happens if that interest rate goes two, three, four points up? We don’t have a country. I mean, if you look at the numbers, they’re staggering.”
Indeed, the Congressional Budget Office projects that interest payments on the federal debt will climb to $500 billion in 2020 from roughly $250 billion this year. That is based on a projection that rates on the benchmark 10-year Treasury will reach 4.1 percent in late 2019, still a low level by historical standards. If rates were to climb more quickly, or reach higher levels, debt payments would be higher.
Pressed to elaborate on his remarks, Mr. Trump did appear to step back. He said that he was not suggesting a default, but instead that the government could seek to repurchase debt for less than the face value of the securities. The government, in other words, would seek to repay less money than it borrowed.
Maya MacGuineas, president of the Committee for a Responsible Federal Budget, said that she shared Mr. Trump’s concern about the size of the federal debt, but that the issue needed to be addressed through changes in fiscal policy — some combination of less spending and more revenue.
“It’s a policy problem, not a debt-management problem,” she said. “When it comes to fiscal responsibility, people are always looking for the easiest of answers. If there were low-hanging fruit here, the Treasury Department would already be on it.”
Repurchasing debt is a fairly common tactic in the corporate world, but it only works if the debt is trading at a discount. If creditors think they are going to get 80 cents for every dollar they are owed, they may be overjoyed to get 90 cents. Mr. Trump’s companies had sometimes been able to retire debt at a discount because creditors feared they might default.
But Mr. Trump’s statement might show the limits of translating his business acumen into the world of government finance. The United States simply cannot pursue a similar strategy. The government runs an annual deficit, so it must borrow to retire existing debt. Any measures that would reduce the value of the existing debt, making it cheaper to repurchase, would increase the cost of issuing new debt. Such a threat also could undermine the stability of global financial markets.
In 1979, for example, what the government described as “bookkeeping problems” temporarily delayed $120 million in interest payments. In the aftermath of the delay, investors pushed up interest rates on Treasuries by about 0.6 percentage point, according to a 1989 study by Terry L. Zivney of the University of Tennessee at Chattanooga, and Richard D. Marcus of the University of Wisconsin-Milwaukee. That cost taxpayers roughly $12 billion.
In 2011, federal borrowing costs climbed as congressional Republicans refused for a time to increase the federal government’s statutory borrowing limit, raising doubts about the government’s ability to repay its debts. The Bipartisan Policy Center calculated that the higher rates will cost taxpayers about $19 billion.
There is a limited opportunity for Mr. Trump to pursue bond buybacks without disrupting markets. He could seek to take advantage of the market’s preference for brand-new Treasuries. In a longstanding quirk, older vintages of Treasuries trade at slightly lower prices than the latest issuance. Treasury officials have discussed issuing new debt to fund purchases of older debt, but they would do so because newer securities are easier for investors to buy and sell. That might improve the workings of financial markets. Any savings, however, would be small change.
“It would not move the needle at all on the overall debt,” Mr. Crandall, the economist, said.
