At a Glance
- After G-20 it’s clear the big three, not OPEC, dominate the global oil picture.
The recent G-20 meeting was full of interesting developments and the market reactions were equally fascinating.
First, the U.S.-China Trade War ceasefire ignited a relief rally in equities lasting all of one day, then returning to up/down volatility without any real trends.
The problem preventing follow through in the equity rally was that the United States and China have different stories on what deal was cut. The U.S. emphasized the 90-day time limit and China’s concessions to buy more goods, especially autos, right away. China focused only on the cease fire as a positive concession from the U.S. to give peace negotiations a chance, and notably China did not even mention the time limit or anything about buying more U.S. goods.
Our take is that both sides felt a need to buy time as China and the U.S. are now seeing some deceleration in their respective economies going into 2019. Still, the odds on a comprehensive deal in Q1 2019 remain very low, as both countries are far apart on agreeing to anything in writing.
The New Big Three in Oil
The second development to watch is the G-20 deal between Russia and Saudi Arabia to coordinate their management of oil production. Market participants got a strong sense that the two countries would curtail production in 2019.
The oil market posted a strong rally. Of course, the oil market had suffered a $20/barrel decline in prices in October and November, so the expectation of some production cuts in 2019 was a welcome relief to producers.
We do caution that the third major producer, the U.S., will see expanded output in the coming year, making it likely that the U.S. will be the largest oil producer in the world for 2019. And, the Russia – Saudi deal makes OPEC somewhat redundant, as the global oil picture is now dominated by the big three producing countries: U.S., Russia, and Saudi Arabia.
Flatter Yield Curve, Wider Credit Spreads
Finally, we note that the G-20 meeting did not happen in a vacuum. The Fed is still on track to raise rates at its December FOMC meeting, but the Fed has dialed back considerably its guidance on future rate hikes, making it clear that if the U.S. economy decelerates, the Fed will halt the rate hikes sooner rather than later.
That change in guidance has led to a weaker U.S. dollar versus other major currencies; a rally in Treasury prices which has taken the 10-year yield back below 3 percent, and a widening of credit spreads between Treasuries and investment grade corporate bonds.
A flatter yield curve and wider credit spreads are not good signs for the U.S. economy in 2019-2020, and we are already seeing fears of sharply slowing growth in corporate earnings. The corporate tax cut effect is now history, and the reality of the lagged impacts from the trade war and rate hikes of 2018 are dampening enthusiasm for equities in 2019.