The Supply Glut Continues with Oil

On Monday, 19 June 2017, Brent crude oil plunged to its lowest price since November 2016. This, on the back of boosted production from major OPEC countries such as Libya, Iraq and Nigeria. Oil futures markets wasted no time reacting to increased production, and mass put options on the commodity took place. Brent crude oil contracts for delivery in August 2017 are trading at $45.89 per barrel, down $1.02, or 2.17%. The 52-week trading range of Brent crude oil is $45.42 on the low end, and $60.21 on the high end. The US equivalent, WTI crude oil for delivery in July 2017 is trading at $43.05 per barrel, down $1.15 or 2.60%. The 52-week trading range for WTI crude oil is $42.75 on the low end, and $58.15 on the high end.

The big story is Libya. The country is now producing its highest levels of crude oil output since 2013, after the state inked a deal with Wintershall AG to continue producing crude oil. Traders across the board are increasingly concerned that OPEC will not be able to make good on its promises of decreased production. This has sent oil markets into sell-off mode and it reflects in lower prices. Across the Atlantic, West Texas Intermediate crude oil numbers are equally bearish. Since the February 23, 2017 high of $54.45 per barrel, oil has plunged some 20%. Any decline of 20% or more is considered the start of a bear market. With WTI crude oil producers and OPEC oil producers continuing to ramp up production, it makes sense that oil prices are dropping. This is evident in the increasing number of US oil rigs in production now.

Stock Markets React Sharply to Falling Oil Prices

On Tuesday, 20 June 2017, the Dow Jones Industrial Average notched up its second day of losses, trading at 21,504.26. Both the S&P 500 index and the Nasdaq composite index traded in the red at 2,444.24 and 6,203.26 respectively. Across the Atlantic, all major European Bourses traded in the red. The CAC 40 was down 0.32% at 5,293.65, the DAX 30 was down 0.58% at 12,814.79 in the FTSE 100 index was down 0.68% at 7,472.71. The biggest losers on the Dow include Chevron Corporation, Nike Inc., The Walt Disney Co., General Electric Corporation and Verizon Communications Inc.

That energy companies are struggling helped to topple Wall Street off its recent highs. It is notable that most all recent gains made by OPEC after its decision to cut production have been given up. Ongoing production by US and Canadian oil producers is keeping the market in oversupply. The sharp pullback in equity markets is the direct result of weakness in oil prices. Recall that rising oil prices are capable of driving up inflation growth in countries where central banks are targeting specific numbers. The Fed is targeting a 2% inflation rate, so is the Bank of England and the European Central Bank. Only the UK has exceeded the inflation expectation with a figure of 2.9% in its most recent reading. The Fed is battling persistently low inflation growth, despite its best efforts at gradual monetary tightening.

How is the GBP performing and how is it affecting the FTSE 100 index?

The governor of the Bank of England, Mark Carney has adopted a dovish position on the GBP, and this is driving the sterling to new lows, while helping to boost the FTSE 100 index to a degree. After the Prime Minister called a surprise election on June 8, 2017, the GBP lost its way alongside the Tories.

The sterling is a barometer of the stability of the UK economically and politically. Now that the Prime Minister’s governing ability is in jeopardy, the GBP is feeling the heat. The pound plunged to its lowest level in two months against the greenback, hitting 1.2625 on 20 June. The relationship between the FTSE 100 index and the GBP is negative. When the sterling retreats, the FTSE 100 index typically prospers. However, weakness in oil markets has led to a risk-off approach to equities markets globally. That the UK negotiating position vis-a-vis the European Union and the Brexit issue is now weakened is not helping matters.

Unfortunately for the GBP, political headwinds had precious little to do with the recent decline in the currency. It is more about economic issues courtesy of the BOE Governor, Mark Carney. Since monetary policy (interest rate adjustments and Bank of England purchases/sales) is a key component of GBP strength or weakness, what Carney says matters. He indicated that the bank rate would remain at its current level until further notice. This has the effect of dampening expectations of a rate hike and it leads to a selloff of the GBP on international currency markets.

Binary options traders wasted no time after this comment and shorted the sterling accordingly. The recent MPC decision went 5:3 in favour of maintaining the interest-rate. What is significant about it is that this marks the first time in 6 years that there has been such divergence between Monetary Policy Committee (MPC) members on the topic of a rate hike. The biggest problem facing the United Kingdom now is rapidly increasing inflation and slow or no real wage growth. This is leading to a cash crunch in the UK economy with personal disposable income levels quickly drying up and GDP about to contract.

What about Market Volatility in Global Indices?

One of the broad measures of current investor sentiment is the VIX (the volatility index). Currently the volatility index reflects low volatility levels in global stock markets. This is somewhat surprising given the Brexit-related anxiety, recent tensions between Russia and the US, and a sharp uptick in oil production among OPEC and WTI crude oil producers. Currently, the CBOE market volatility index is up 6.46% at 11.04, with a sharp rise since Monday, 19 June, owing to oil price concerns. The index has a 1-year change of -39.90%, indicating a sharp drop in negative sentiment since the oil price concerns and Brexit issue hit the global markets.

Even the fear and greed index of CNNMoney is sharply lower and considered neutral. In the United States, much of the bearish sentiment that is pervasive throughout markets is based on political mudslinging more than it is on economic weakness. While everyone is decrying Trump Trade, the US president has yet to push through major legislation to make good on his election promises. If tax law reform and a health care overhaul are enacted, the US economy may receive a much-needed bolus of adrenaline that investors are so eagerly awaiting.