Week 25 In Review

Oil Enters Bear Market

For the week ending 23 June 2017

· Crude oil prices decline more than 20% from recent highs

· Brexit negotiations begin

· BOE governor, economist split over rate moves

· MSCI admits China’s A shares

· Fed’s Powell OK with relaxing Volcker rule

Global equities slipped overall this week, but not before the S&P 500 Index posted a fresh record high early on. Falling oil prices have been a cause for investor concern. West Texas Intermediate crude continued its decline, slipping to $42.65 a barrel on Friday from $44.70 a week ago, trading near a seven-month low. The yield on the US 10-year Treasury note was virtually unchanged, while volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), declined slightly to 10.6 from last Friday’s 10.9.

GLOBAL MACRO NEWS

Crude oil prices deepen slump

The price of a barrel of West Texas Intermediate crude oil extended its decline this week amid rising global inventories. WTI prices have fallen in excess of 25% from their $58.30 high, which was posted on the year’s first trading day. Energy company shares have been under pressure, while spreads in the sector’s high-yield bond market have widened over benchmark Treasury yields this week. The sharp decline in energy prices will make it that much more difficult for the US Federal Reserve to reach its 2% inflation target in the foreseeable future.

Brexit talks underway

Negotiators from the United Kingdom and the European Union met on Monday in the first formal Brexit negotiating session. The one breakthrough from the talks was the UK’s acquiescence to EU demands that the divorce bill must be settled before the EU begins to negotiate a new trade arrangement. Late in the week, Prime Minister Theresa May met with EU leaders in Brussels and laid out her plan to protect the rights of the three million EU citizens living in the UK, allowing them permanent residence. May called on leaders to grant British citizens living in the EU the same rights.

To hike or not to hike?

That is the question on the minds of the members of the Bank of England’s Monetary Policy Committee. While UK growth has suffered a downturn of late, inflation has surged on the heels of a tumble in the pound’s exchange rate. Rising import prices have pushed consumer prices up 2.9% versus year-ago levels, prompting three members of the short-staffed MPC to vote for a rate hike last week against five votes to leave policy unchanged. The divide deepened this week as the Bank’s two most high-profile officials came out on opposite ends of the question of whether rates should be raised this year. BOE governor Mark Carney made the case that now is not the time for rate hikes given low wage growth and mixed signals on consumer spending and business investment. BOE chief economist Andy Haldane countered that it would be prudent to raise rates in the second half of this year to counter the inflation surge. It is rare for a central bank to defy the will of its leader, and it appears unlikely to happen in this instance given recent shifts in the MPC’s composition.

China gets nod from MSCI

After years of fighting for inclusion in MSCI’s influential stock indices, China finally received word that some of its A shares will be included in the indices in mid-2018. Just fewer than half of the 448 A shares will be included in the indices and at an initial weighting of just 5% of each stock’s market cap. These restrictions are an effort by MSCI to incentive China to further liberalize its stocks markets.

Room to relax

Fed governor Jerome Powell told a congressional committee that US regulators have room to relax or eliminate some aspects of the Volcker rule, which is intended to limit banks’ ability to make speculative bets with insured deposits. Regulators are looking for ways to simplify the complicated rule and may exempt small banks from having to comply, Powell said.

Treasury secretary rejects one-off ultra-long bond

US treasury secretary Steven Mnuchin this spring floated the idea that the United States is considering issuing very-long-dated bonds. This week he said the government will only issue ultra-long maturity Treasuries if there is sustained appetite for the securities. Mnuchin said his department is reaching out to investors in order to gauge demand for instruments with maturities between 50 and 100 years, but any move to issue very-long-term debt would not be a one-off. Apparently there is at least some investor demand for long paper, as Argentina issued 100-year bonds this week despite having defaulted six times in the last century. The issue, although rated below investment-grade, was heavily oversubscribed.

US banks clear first round of stress tests

Thirty-four big US banks passed the first round of the Fed’s stress test this week. Next week, the central bank will announce whether it will allow the banks to return capital to shareholders. Some banks may begin to reduce their capital if the Fed approves. That could be seen by markets as a sign of confidence that the banking system is strong and positioned well to withstand a significant economic downturn.