Temperatures are set to reach the low twenties in the UK this week, but the weather isn’t the only thing hotting up. First, the biggest headline last week was on the geopolitical front with the US, the UK and France engaging in “targeted” airstrikes on suspected Syrian government chemical weapons facilities.
In addition, the minutes from last month’s meeting at the Federal Reserve, released last week, point towards fears of an overheating economy with a number of Fed officials predicting the path of rates may need to be steeper than previously thought. For now, this has largely been ignored by the market; asset class returns in sterling and local currency are below showing equities clawing back lost ground from the week before. Notably the US market is broadly back to its starting point from the beginning of the year.
Table 1: GBP total returns
Table 2: Local CCY total returns
The price of oil has been a clear beneficiary of the rising tensions in the Middle East; though Syria itself has not typically been a major oil exporter, a number of state actors in the region (including Russia, Iran and Saudi Arabia) are. Saudi officials signalled an aspiration for $80 per barrel oil ahead of the planned IPO of state owned energy giant Aramco, expected in 2019. The oil price was given a further boost on Wednesday on reports that Iranian-backed Houthi rebels fighting a civil war in the Yemen fired a ballistic missile at the Saudi capital which was soon intercepted.
Chart 1: US Department of Energy report on Total Crude Oil Production (000s of barrels per day)
Source: Bloomberg, US Department of Energy
There remains significant risk to the stability of energy markets, most pertinently the possibility of structural change to Russian crude oil supply. Existing sanctions aimed at Russia’s energy sector, put in place in August 2017, have so far not had a significant impact on oil exports. However, more recent targeted sanctions on Russian oligarchs and government officials (i.e. Rusal, the Russian aluminium producer) in response to the alleged Syrian chemical attacks may be of more concern given the scope. The Trump administration has the ability to cause widespread disruption to global energy markets; a key barometer for investors regarding President Trump’s policy will be the deadline on 12th May to extend the waiver on sanctions imposed on Iran, the other key regional backer of the Syrian regime.
The effect of the collapse in the oil price in 2014-15 was a key dis-inflationary force, suppressing both consumer and producer inflation measures. The circumstances mentioned above risk higher energy prices feeding into higher inflation expectations which will have knock on effects regarding the global economy. Minutes released last week from the Federal Open Market Committee (the Fed’s interest rate decision body) meeting in March revealed a number of participants thought “the appropriate path for the federal funds rate over the next few years would likely be slightly steeper than they had previously expected”. Fears already exist among investors that the Fed’s policy tightening cycle is too aggressive and subsequently may cause US economic activity to slow. Should external inflationary pressures, such as rising energy prices, cause inflation to overshoot targets, it is probable that central bank over action may cause more harm than good.
Chart 2: Brent and WTI crude spot prices indicating current price is highest since 2014 collapse
THE WEEK AHEAD: US retail sales (Mon), Chinese GDP and UK unemployment (Tues), UK inflation (Weds), Japanese inflation and Eurozone consumer confidence (Fri).
STAT OF THE WEEK: Circa 40% of Republican and 20% of Democrats will not be seeking re-election in the November mid-terms (Deutsche Bank).
Data correct as at 13/04/2018.