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  • Oil free-fall is positive for fuel costs and lower inflation but has negative consequences for energy stocks and bonds
  • Core CPI expected to be steady
  • Mnuchin’s involvement in US/Chinese talks will hopefully come out better than last time  
  • Crunch time arrives as PM May must get Brexit deal approved by her cabinet at today’s key meeting

Oil free-fall is positive for fuel costs and lower inflation but has negative consequences for energy stocks and bonds — Dec WTI crude oil prices on Tuesday saw an extraordinary plunge of -7.07% to an 11-month low, extending the month-long plunge to a total of -28.6%.

Oil prices were already on the ropes going into this past weekend’s OPEC+ monitoring committee meeting due to the Trump administration’s unexpected announcement on Nov 5 of Iran sanction waivers for eight countries worth some 1.0-1.25 million bpd of continued Iranian oil exports.

Oil prices extended the plunge this week despite the fact that Saudi Arabia on Sunday said it would cut production by some 500,000 bpd in December to reverse recent production increases.  Bearish factors this week include (1) uncertainty about whether there will be a significant OPEC+ production cut for 2019 after Russia at the weekend OPEC+ meeting delayed a decision on production cuts, (2) President Trump’s tweet on Monday excoriating Saudi Arabia and OPEC for considering a production cut, and (3) OPEC’s cut on Tuesday in its 2019 global crude demand for OPEC crude by 500,000 bpd to 31.5 million bpd from September, which is a hefty 1.4 million bpd below its current production level.

The prolific U.S. crude oil outlook has also been instrumental in greasing the skids for crude oil’s plunge.  U.S. oil production in last week’s EIA report rose by +3.6% w/w to a new record high of 11.6 million bpd.  U.S. oil production in the past year has soared by roughly 2 million bpd, more than offsetting OPEC’s production cuts.  U.S. oil inventories are also rising and are now 3.1% above the 5-year seasonal average, the highest such level since February.

The plunge in oil and fuel prices is a net benefit for the U.S. economy since it reduces inflation expectations and also puts more cash into the pockets of businesses and consumers via lower fuel costs.  Indeed, the 10-year breakeven inflation expectations rate has fallen by -5 bp this week to 2.03%, thus taking some of the pressure off the Fed for rate hikes.

The fall in oil prices also has negative consequences, however, by causing a hit to U.S. economic growth in the oil sector and forcing a sharp drop in energy stocks and bonds.  Indeed, the SPDR S&P Oil and Gas Exploration and Production ETF (XOP) has fallen by -5.4% so far this week has is down by -22% since early-October.

 

Core CPI expected to be steady — The market consensus is for today’s Oct CPI to rise to +2.5% y/y from Sep’s +2.3% but for the core CPI to be unchanged at +2.2% y/y.  The CPI has eased from July’s peak.  Both the CPI and the core CPI showed an annualized gain of only +1.8% over the last three months (July-Sep).  However, the core PCE deflator in recent months has been locked at a 7-year high of +2.0%.  The fact that the Fed’s preferred inflation measure is right at the Fed’s target means that the Fed has already met its inflation goals and needs to continue raising the funds rate to at least the perceived neutral rate of 3.0%.

 

Mnuchin’s involvement in US/Chinese talks will hopefully come out better than last time — The markets were encouraged by Tuesday’s WSJ report that Treasury Secretary Mnuchin spoke by phone last Friday with Chinese Vice Premier Liu.  There were also reports that Vice Premier Liu, Chinese President Xi’s right-hand man on economic and trade policy, will visit Washington for talks later this month.  

The Mnuchin-Liu conversation boosted market hopes for at least a cease-fire agreement when Presidents Trump and Xi meet on the sidelines of the G-20 meeting on Nov 30/Dec 1.  If those talks are not successful, then Mr. Trump has already threatened to slap tariffs on the remaining $257 billion of Chinese goods and proceed with his current plan of raising the tariff to 25% from 10% on $200 billion of Chinese goods on January 1.

The markets are hoping that Mr. Mnuchin will be more successful than last time in getting Mr. Trump to fully support any trade deal that is being discussed.  Back in May, Mr. Mnuchin thought he had a trade deal after talks with Vice Premier Liu in Washington, but within a day Mr. Trump had second thoughts after criticism from trade hardliners and he deep-sixed the deal.  Chinese officials have since been reluctant to negotiate on trade since they are unsure of who has the power to negotiate and whether Mr. Trump would fully commit to any trade deal.

Crunch time arrives as PM May must get Brexit deal approved by her cabinet at today’s key meeting — Prime Minister May is holding a critical cabinet meeting today where she will attempt to get her cabinet to approve the separation agreement she reached with the EU.  That agreement was announced on Tuesday.  If she cannot get her cabinet to agree to the deal, she might go back to the EU for new negotiations, or she might take more drastic action such as threatening to resign as Prime Minister or call new elections.

If Ms. May can cajole her cabinet into approving the deal, then the EU may hold a special summit as soon as November 25 to approve the deal.  The question then will be whether Ms. May can get Parliamentary approval for the deal, which is going to be very difficult due to opposition from Brexit hardliners and the reluctance of the opposition Labour Party to help her push a Brexit deal over the finish line.  If Ms. May can’t get Parliamentary approval for a separation deal, then the odds will quickly grow for a hard exit from the EU common market in March 2019.  In that case, a hard customs border will suddenly arise between the UK and Europe with tariffs at generic WTO levels and with shortages of many goods due to shipping delays. 

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