IronFX Daily Commentary | 27/03/15

US yields rise on jobless claims, USD benefits EUR/USD did manage to get over 1.10 yesterday for a relatively long time – about five hours – but it was already back below that level when the US jobless claims came out better than expected. Even if many of the US economic indicators are missing expectations, the labor data remains strong, and that’s one of the two key points for the Fed. Growth isn’t in the Fed’s mandate, “maximum employment” is. Signs of continuing strong employment sent Fed funds rate expectations and bond yields higher and supported the dollar all around. Talk of the end of the dollar rally was quite premature! The markets will be waiting to hear what Fed Chair Janet Yellen has to say on the topic later today (see below).

Japanese data as expected Early Friday we had the usual end-of-month data dump from Japan. The key point was that the Bank of Japan’s measure of inflation that takes into account last year’s hike in the consumption tax showed inflation at zero in February. So much for their goal of hitting 2% inflation by April 2015! The jobless rate and job offers-to-applicants’ ratio, also for February, both improved as expected. The government hopes that this tightening labor market will put pressure on companies to raise wages, which would help to create “good” demand-pull inflation (instead of “bad” cost-push inflation caused simply by oil prices rising, which eats into peoples’ purchasing power). Dream on. Household spending for February fell on a yoy basis, although not as much as expected, and retail trade rose less than expected on a mom basis – although large retailers’ sales beat expectations. Some major companies have increased their wages modestly, but there’s no sign yet that households in general are feeling any richer or spending any more as a result. I expect Japan will continue to rely on monetary stimulus and currency depreciation for growth, which is why I remain bearish JPY.

More on why I’m bearish on oil Yesterday I observed that at the current rate, storage at the main US oil distribution facility of Cushing, Oklahoma will be full by the end of June. I’d like to elaborate on that point to explain why I’m still bearish on oil (assuming no disaster in the Middle East).

Everyone thought that US production would drop as prices dropped because so much of US production is from “fracking,” which is expensive. However, that hasn’t happened. On the contrary, US oil production keeps climbing and may be at a record level. However, US producers aren’t allowed to export oil. So much of the increased supply is going into storage. Inventories have risen for 11 weeks in a row, the longest rising streak on record, and are now at record levels, too.

Unfortunately there’s a limit to how much oil they can put in storage. There’s just so many oil tanks in the world. Inventories at Cushing have been rising by a little over 2mn barrels a week this year. Cushing only has storage for 85mn barrels of oil. At this rate, all the tanks in Cushing will be full by late June. After that, there’s nothing they can do except to dump the oil on the market at any price.

That would be bad enough, but it gets worse! Production in the US is likely to rise, because of regulations in North Dakota, the #2 oil-producing state after Texas. There are around 125 wells in the state that have to be finished by the end of June in order to comply with state requirements to complete drilling within a year. At the same time, oil taxes in North Dakota will probably fall in June, because the state reduces taxes when prices average below a certain level for five consecutive months. That would mean most of the wells in the state will be exempt from the oil extraction tax. The combination of that tax break and many wells running up against one-year state deadlines means an increase in production in North Dakota.

So in June, US oil production is likely to surge just as the storage tanks get full! If that happens, then oil prices may plunge. Actually, they’re likely to plunge before that, as investors get ready for the eventuality. That’s why I’m bearish on oil over the next several months – and on the oil currencies, particularly CAD, NOK, AUD and RUB.

Of course, this depends on my assumption that the fighting in the Middle East doesn’t interfere with oil production or shipping there. If it does, then all bets are off. That could change the total environment for financial markets.

Today’s highlights: During the European day, French consumer confidence for March is coming out.

From Sweden, retail sales for February are forecast to decelerate a bit. Following the poor economic tendency survey released on Tuesday, another weak figure is likely to weaken SEK somewhat.

In Norway, the official unemployment rate for March is expected to remain unchanged at 3.0%, while retail sales for February are forecast to rebound from the previous month. On top of the higher oil prices due to the fighting in Yemen, the positive data are likely to keep NOK supported.

In the US, the 3rd estimate of the Q4 GDP is expected to show that the US economy expanded at a faster pace than the 2nd estimate. The 3rd estimate of the core personal consumption index, the Fed’s favorite inflation measure is also coming out. A strong reading could strengthen USD. The final University of Michigan consumer sentiment for March are coming out along with the surveys of 1-year and 5-to-10 year inflation expectations.

Four central bank governors and one Vice Chair speak Friday: Bank of England Governor Mark Carney, Fed Vice Chair Stanley Fischer, Riksbank Governor Stefan Ingves, Norges Bank Governor Oeystein Olsen and Fed Chair Janet Yellen. Yellen Is speaking on monetary policy at a San Francisco Fed conference entitled, “The New Normal for Monetary Policy.” She will also take questions from the audience.