John Kemp –
Oil prices are sinking again as concerns about the health of the global economy and petroleum consumption replace fears about the vulnerability of Saudi Arabia’s infrastructure as the main focus for traders.
Recent economic data has painted a mixed picture about whether the global economy is flatlining or pulling out of the slowdown that hit during the second half of 2018 and the first half of this year.
But the broadest indicators of business activity and investor sentiment continue to suggest an economy growing well below trend. Investors are positioning themselves defensively in case growth slows further.
Global manufacturers reported that new export orders fell in August for the 12th month running and the decline is accelerating.
The JPMorgan purchasing managers’ sub-index for new export orders last month fell to its lowest since the mid-cycle slowdown in 2012 and before that the recession of 2009.
World trade volumes fell during the second quarter compared with the same period last year at the fastest rate since the post-crisis recession, according to the Netherlands Bureau for Economic Policy Analysis.
Oil consumption among the top 18 consuming countries, each using more than 1 million barrels per day, rose by just 0.9 per cent in the second quarter compared with the same period in 2018.
Oil consumption by the top consumers was growing well below the trend rate of 1.5 per cent per year that prevailed between 1998 and 2018, data from the Joint Organisations Data Initiative showed.
In the United States, new orders for non-defence capital goods excluding aircraft, a proxy for business investment, were up less than 0.5 per cent in the May-July period versus a year earlier.
Business investment spending was growing at the slowest rate since the mid-cycle slowdown or mini-recession of 2015/16 and well below the average rate over the last 20 years.
Financial markets continue to signal a cautious approach from investors on the outlook for economic growth and corporate profits in the short to medium term.
The US S&P 500 equity index has risen by only around 3 per cent in the last three months compared with the same period in 2018, well below the average of the last two decades.
US share prices have underperformed despite two interest rate cuts by the Federal Reserve and a sharp drop in bond yields, which should have increased the discounted value of future profits.
The implication is that investors have become much more pessimistic about the prospect for corporate profits in the next few years.
The US Treasury yield curve for maturities between three months and 10 years has been continuously inverted for nearly four months.
Sustained inversions of three months or more have been a reliable signal of an approaching recession for the last 50 years.
The curve has remained deeply inverted despite two quarter-point rate cuts by the central bank since the middle of the year.
Other things equal, rate cuts should have reduced the degree of inversion by pulling down rates at the short end of the curve.
But the deteriorating outlook and increased risk aversion among investors have pulled down the long end of the curve too.
The Federal Reserve Bank of New York’s yield curve model implies there is a probability of well over 30 per cent that the economy will be in recession in August 2020.
If that probability still seems fairly low, the economy has been in recession for only about 13 per cent of all months since 1960.
The current slowdown could be a temporary soft patch in an otherwise sustained expansion, or it could mark the beginning of the end of the expansion.
Current data is inconclusive, but business executives and financial investors have started to adopt a more defensive position and prepare for a downturn.
In the circumstances, it is not surprising oil prices have remained under pressure, with consumption growth likely to be below trend in 2019 and 2020.
Relatively low prices are needed to enforce a matching slowdown in output growth by both Opec and US shale producers and avoid a large build in inventories next year. Until the global economy shows clearer signs of pulling out of its slough, oil prices will struggle to rise on a sustained basis. — Reuters