Daily Agenda: Oil Prices Finding Footing

Greek pols go on German visit; GlaxoSmithKline and Merck post results; European sovereign debt trades on negative yields.


David Paul Morris

A sudden, dramatic spike in oil prices during the past two trading sessions has left many investors scratching their heads. If global oil markets do bottom out near current levels, there would be broad implications for the financial markets. In a note to clients yesterday, Brian Reynolds, chief investment strategist at Rosenblatt Securities, noted that the recent turmoil in the equity markets has been closely tied to West Texas intermediate crude prices bouncing within a $44.19 to $51.27 range and now that the price has risen above the upper threshold, “This move probably brings the financial market correction to a close.” While Reynolds warns of the potential for a “head fake” and is adamant that this does not portend a new bullish cycle for energy, his thesis is that a stop in crude’s free fall grants investors greater confidence in financial asset valuations as they recalculate macro and geopolitical risk factors.

Greece sends delegation to Berlin. Greek Finance minister Yanis Varoufakis arrived in Germany today for a two-day visit to discuss his country’s debt situation. Both European Central Bank president Mario Draghi and German Finance minister Wolfgang Schäuble have publicly spoken against outright debt forgiveness for Greece but Varoufakis is believed to be pushing a shift in terms that would retain the current principal amount of outstanding bonds while lowering the near-term servicing cost.

European sovereign debt trades on negative yields. A J.P. Morgan research report released on Monday estimated that, on an inflation-adjusted basis, $3.6 trillion in European sovereign debt has traded at negative yields since the ECB announced its quantitative easing facility. Although the factors driving investor demand at these levels are multifaceted, it strongly suggests that market participants are factoring in further deflationary pressure for the region.

Service sector in Europe shows rebound. In data released today, final Markit nonmanufacturing index levels for January registered the strongest showing since July 2014. Euro zone aggregate levels came in at 52.6, beating consensus forecasts. Separately, Eurostat retail sales figures for December indicated that total 2014 consumer spending reached a multiyear high.

Pharma companies give earnings prognosis. GlaxoSmithKline and Merck both announced fourth-quarter earnings today. GlaxoSmithKline announced a significant decline in returns for the final three months of 2014, driven in part for weaker demand for asthma drug Avair. In the U.S., Merck fell marginally short of consensus analyst estimates while issuing a downbeat forecast for 2015, largely on the back of currency shifts. Prudential Financial is among the several companies reporting today after equity markets close.

Portfolio Perspective: Priming The Pump For Increased Global GrowthAron Gampel, Scotiabank

The transition to a stronger growth environment internationally is still proving elusive, with, on average, the pace of global activity to change little. Even so, there are several reasons why we believe that momentum will build as the year progresses, with broader economic gains expected next year.

First, the U.S. economy is on the cusp of stronger and more sustainable activity. A self-reinforcing cycle is underway, with increased consumer spending reinforced by rising employment and considerable pent-up demand; business expenditures underpinned by large backlogs of capital goods orders, especially in the large transportation sector; and reduced fiscal restraint adding to the renewed momentum.

Second, the sharp and sustained slide in the price of crude oil is providing consumers internationally with a massive tax cut. Sales of large motor vehicles such as sport-utility vehicles are rising in the U.S. and China. Businesses benefit from the sharp reduction in the price of a key input cost as it ripples through supply chains. Oil-importing countries, especially the large energy-intensive countries such as China, Indonesia and Thailand, as well as the U.S., stand disproportionately to benefit.

Third, inflation and borrowing costs have continued to decline around the world, outside of countries with structurally weak economies where rate hikes have been needed to restrain rising inflation, arrest capital outflows and stabilize currencies.

Fourth, currencies have become an integral part of the adjustment process. Many exchange rates have weakened against the U.S. dollar — a reflection of the comparatively stronger growth in the U.S., and the divergence in respective monetary policies — and will likely continue to do so and help resuscitate export earnings.

And last and fifth, there will be increasing pressure on governments which are financially capable to expand infrastructure investments and help bolster the collective weakness in demand.

Aron Gampel is a vice-president and deputy chief economist of Scotia Capital, part of Scotiabank, in Toronto.