Today’s Economic Preview & Perspectives #Futures

Weekly market focus — The markets this week will focus on (1) oil prices after sanctions on Iran were dropped over the weekend, thus allowing Iran to boost production and exports as quickly as they can from a technological standpoint, (2) the Chinese stock market as the Shanghai Composite index on Monday closed mildly higher by +0.44%, stabilizing after last Friday’s -3.55% plunge, (3) European stocks as the Euro Stoxx 50 index on Monday fell -0.58% for a 3-session decline totaling -4.55%, (4) the more dovish view of Fed policy in the wake of the recent turmoil with the markets now deferring expectations for the Fed’s next rate hike until December, and (5) the first big week for Q4 earnings.

Chinese stock market on Monday stabilizes ahead of Monday night’s Chinese economic data — The world stock markets on Monday closed mixed but saw continued downward pressure as oil prices fell another notch after Sunday’s news that sanctions against Iran were dropped.  The Shanghai Composite index on Monday rose by +0.44%, stabilizing somewhat after plunging for three straight weeks by a total of -21%.  The Chinese markets were on edge ahead of last night’s release of a slew of Chinese economic data including Q4 GDP (expected +6.9% y/y, unchanged from Q3’s level), Dec industrial production (expected +6.1% y/y, unchanged from Nov’s +6.1%), and Dec retail sales (expected +6.0% y/y vs Nov’s +6.2%).

 

Crude oil prices fall to new lows as Iranian sanctions are dropped — March Brent crude oil futures prices on Monday posted a new 12-year low of 27.70 on the nearest-futures chart and closed -0.73% (-0.21 at $28.73) after Sunday’s news that sanctions on Iran were dropped.  Iran can now produce and export as much oil as it wants.  The -25% plunge in Brent crude oil prices in the past two weeks has mainly been due to expectations for Iranian sanctions to be dropped during January, sooner than earlier thought.  Comments by Iranian officials last week suggested that sanctions would be dropped over the weekend, which means that Sunday’s announcement was not a surprise for the markets.  March Brent crude oil futures last Friday plunged by -6.28% in anticipation of the weekend announcement.

The question now is whether oil prices have fallen far enough to discount the upcoming flood of Iranian oil into a global oil market that is already experiencing an epic glut.  Whether oil prices see new lows in coming weeks will depend mainly on how fast Iran ramps up its production.  Iran on Monday issued an order to boost production by 500,000 bpd as soon as possible.  Iran also has a huge amount of oil in floating storage that it can sell into the market immediately.  The IEA says that Iran has 12 million barrels of crude oil and 24 million barrels of condensates in floating storage.

The market consensus is that Iran’s production and exports will rise by 100,000 bpd in the first month after sanctions are lifted, by 400,000 bpd after 6 months, and by 700,000 bpd after 1 year.  Iranian officials in recent months have offered much more aggressive predictions, saying that they can increase production by 500,000 bpd within weeks of when sanctions are lifted and by 1 million bpd within a year.  Iran’s current production level of 2.7 million bpd is about 1 million bpd below the 3.75 million bpd level that prevailed before sanctions were imposed on Iran over its nuclear program.

Markets now expect only one 25 bp rate hike in 2016 — The market turmoil seen so far this year has caused the federal funds futures market to now expect only one +25 bp Fed rate hike by December versus previous expectations for two rate hikes, one by June and the second by December.  The Fed dots are much more hawkish and reflect FOMC forecasts for four rate hikes during 2016.  The Dec 2016 federal funds futures contract so far this year has plunged by -28 bp to 0.61% from 0.89% at the end of 2015.  Meanwhile, the Dec 2017 federal funds futures contract has fallen by -47.5 bp to 0.955% from 1.43% at the end of 2015.

The fresh plunge in oil prices will put an even larger dent in the U.S. economy via the petroleum sector recession and has also pushed inflation expectations lower.   The 10-year breakeven inflation expectations rate, which measures the difference between nominal and TIPS 10-year T-notes, fell to a 3-1/2 month low of 1.39% last Friday.  The plunge in oil and commodity prices in general means that there is little chance that inflation will be moving higher this year and that the Fed will remain far behind on hitting its 2% inflation target.

Q4 earnings season ramps up — This will be the first big week for Q4 earnings with 42 of the S&P 500 companies scheduled to report.  Notable reports include Morgan Stanley, Bank of America, and IBM today; Goldman Sachs and Northern Trust on Wed; American Express and Starbucks on Thurs; and GE on Friday.  The market consensus is for Q4 SPX earnings to fall by -4.7% y/y, worse than expectations of +1.1 on Oct 1 when Q4 began, according to Thomson I/B/E/S.  However, earnings growth is then expected to improve in 2016 with SPX earnings growth of +0.7% in Q1, +2.9% in Q2, +7.4% in Q3, and +14.6% in Q4.  On a calendar year basis, the consensus is for SPX earnings growth to improve to +6.8% in 2016 from -0.1% in 2015.

U.S. home builder confidence expected to be unchanged — The market is expecting today’s Jan NAHB housing market index to be unchanged at 61 following December’s small -1 point decline to 61.  The NAHB index posted a 10-year high of 65 in October but then fell by a total of -4 points in Nov-Dec.  Home builder confidence is likely to sag in early 2016 due to the market turmoil seen so far this year.