Oil leads thought-provokers of the week

The events in the Middle East give hope that democracy may take hold in the region. Yet the situation is very delicate, as the risk of greater instability is growing and people are suffering. Few people believed that the events we are witnessing could indeed happen, and it is difficult to forecast how the situation will play out

The oil supply risk is fuelling fears about global economic growth and has led to profit taking on the market. Still, the equity market correction has been moderate, with the MSCI World ($) losing 3% from its earlier high. Risk-adverse investors have started to buy Swiss Francs. The Chf/$ exchange rate has hit an historic low, trading below 0.93. Gold has bounced back to above $1,400/oz, and the Brent crude oil contract reached levels close to $120/bbl on Thursday.

German downgrades

Moody’s downgraded German banks’ subordinated debt. The move affects 248 lower Tier 2 securities issued or backed by 24 banks, currently valued at around Eur24bn. The move comes as new legislation is expected to increase the risk that holders of subordinated bank securities may experience losses. The regulation allows authorities to impose losses on debt holders without necessarily placing the entire bank into liquidation.

As part of the tougher rules to handle bank failures, the German legislation significantly reduces the likelihood of government support for subordinated bank securities. It is enough to look at who is holding these bonds to know who needs to brace for losses.

Eurozone expectations

In February the eurozone composite purchasing managers index (PMI) reached its highest level since July 2006. It rose much more strongly than anticipated, from 57.0 to 58.4, reflecting a sharp increase in both the manufacturing and services indices. The rise further fuels hopes that the eurozone recovery regained momentum at the start of 2011. Separately, the German Ifo business climate index climbed to an all-time high of 111.2 from 110.3 in January, adding to evidence that GDP growth in Germany will accelerate sharply in Q1 2011 after slowing in Q4 2010.

Despite the latest data, the divergences between the core and the peripheral eurozone economies look set to remain. This again puts more pressure on ECB policymakers to decide on a monetary policy that is neither too tight nor too loose.

Italian disruptions

The Italian yield curve has steepened and the equity market corrected, driven by uncertainty caused by the unrest in Libya. Italy is not only linked to Libya in terms of oil and gas (14% of ENI’s production in 2009 came from Libya). The Libyan government is also investor in some Italian companies.

The disruption of the 540-kilometer ENI underwater natural gas pipeline from Libya to Sicily shows how this unrest can indirectly impact the developed world. What could be the way out? Alternative energy or diversification of providers?

US orders

US durable goods orders increased in January, while US initial jobless claims were lower than expected. The durable goods orders increase in January came after a drop in December, which was mainly due to increased demand for aircraft. The decrease of 22,000 in initial US jobless claims indicates that the labour market is improving.

US data continues to give support to the scenario of a slow but growing global economy. However, it remains to be seen if companies start to increase hiring and put their capital to work by investing in new projects. As of now, the economy is not yet creating enough new jobs.

Cereal surprise

Corn production has fallen to a 37-year low, signalling that farmers are not able to produce enough grain to meet rising consumption. Although annual output of wheat, rice and feed grain has risen by 16% since 2000, this is not enough to keep up with a 20% annual increase in demand.

The US Department of Agriculture (USDA) predicted this week that global inventories for grain will fall by another 13% before the next harvest, even as planting expands and food prices surge. World stockpiles will be at a meagre 15% of use, the lowest level since 1974.

Global consumption will continue to rise alongside rising income and fast urbanisation in developing countries, as people eat more meat and dairy products from crop-fed livestock. This drives demand for corn and soybeans.

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