Home' Trinidad and Tobago Guardian : October 16th 2014 Contents West Texas Intermediate
(WTI) crude oil fell 4.6
per cent to record its
worst week in nine
months. Over two
weeks, the drop is 8.5 per cent, which is the
biggest decline since June 2012 and puts WTI
into bear market territory. Brent Crude, which
is the more global benchmark, fell below
US$90 per barrel for the first time in over
Why should oil prices fall given the tensions
in the Middle East and sanctions against
another key oil producer Russia? It seems
counter intuitive and at variance from the
past 40 years that oil will fall with higher
In addition, almost every Wall Street analyst
who forecasts interest rates and even most of
my colleagues in T&T had suggested at the
start of the year that ten-year interest rates
in the US would rise from three per cent to
around 3.75 per cent by now. On Friday last,
the benchmark bond closed below 2.30 per
cent. How did everyone get it so wrong?
In Europe, the yield on the German ten-
year was a stunning 0.88 per cent while in
the two year investors are actually paying for
the right to put their money in the German
note as the yield is negative 0.05 per cent.
Add to the mix the recent volatility in the
US stock market where the Dow Jones Indus-
trial Average was down 274 points on Tuesday,
up 275 on Wednesday and then down 330
points on Friday. The index had given up all
its gains for the year and the S&P was trading
at its 200-day moving average going into
earnings season this week.
If the above moves seem confusing, it should
not really be so for regular readers as many
of the current issues facing the market have
been explained long ago, in some cases going
back more than a year.
The answers to today s market conundrum
where identified back in June of last year in
this space and repeated on February 13 this
year under the headline, Going Against the
Consensus. In that article, I suggested that
rates were heading lower not higher and
repeated a call first made on June 27th 2013
that the range for the ten-year US treasury
bond would be in the 2--2.60 per cent region.
Appreciate that going against the consensus
view is not an easy thing to do, especially in
an investment context. In the first instance,
you are making a call that is different to the
majority of your peers most with bigger rep-
utations and overseas branding to their name.
They are looking at the same information,
but coming to a different conclusion.
Secondly, the market, at least for a time,
is likely to trade with the consensus view so
not only is there a difference of views, there
is also the fact that the contrarian investment
is likely to lose money in the short term as
the market goes against you. That is a double
whammy and can over time create doubt.
Often times you are second-guessed by the
clients whose funds you are managing. It
requires a fair amount of conviction to see it
through and more to publicly express the view.
That, however, is the job of an investment
adviser, but it also explains why there is what
is referred to as the "herd mentality" on Wall
Street and in investment circles as many are
content to simply go with the flow and then
blame the market if they are wrong.
At the beginning of the year, the US ten-
year was at 3.02 per cent. At that time, my
view was that at those rates the full effect of
Fed tapering was already priced in. In order
for rates to move higher from there required
another catalyst, one which I did not see on
In that February 13, article I reiterated the
issues that would come into play for bond
yields. The point was made that the path for
US interest rates was dependent not just on
the US Federal Reserve, but rather was a global
situation. Europe, Japan and, to a lesser extent,
the emerging markets all have a role to play
in the outlook for interest rates. To put it sim-
ply, we are well and truly into what can only
be termed "the currency wars".
The US and the UK were the first two major
economies to embark on a quantative easing
programme. The effect of this, especially as
it relates to the US dollar, was that the dollar
would fall against other major currency pairs.
The weak dollar ostensibly pushed up the
price of commodities such as gold and oil and
also made US exports more competitive. It
also meant that US companies would have
had a boost to profits from converting the
stronger global currencies into dollars, a feature
that was good for stocks.
Over the past year, the US Fed has begun
to taper its bond purchase programme and
from late 2012, early 2013, Japan started its
own round of money printing. This caused
the Yen to fall against the dollar and over the
ensuing period the yen has lost over 40 per
cent of its value against the dollar.
The same dynamic is at play in Europe.
The European Central Bank is pursuing a loose
monetary policy while the US Fed is becoming
less accommodative. Once again this results
in a reversal in the euro/dollar rate with the
euro moving from close to 1.40 to 1.25 against
the dollar over the last few months.
As a result of the falling yen and duro against
the dollar an investor who purchases a bond
denominated in those currencies may get a
yield, but will see those returns reduced by
the currency movement if the investor is using
the USD as their functional currency.
It therefore made/makes more sense to go
into US treasuries where the yield is not only
higher than in Europe and Japan, but the cur-
rency effects are muted. This has kept US
rates low despite the fact that the Fed action
now reflects a tighter monetary policy.
For reference the reason why rates amongst
European sovereigns are lower than the US is
due to the fact that Europe is experiencing
disinflation and is at risk for outright deflation.
In such circumstances, euro dollars flows into
euro sovereign instruments and the increased
demand pushes yields down. Germany is the
best rated duro econom,y hence the negative
yield on their two-year note.
Adjusting yields for inflation brings per-
spective to the discussion. In the US, a ten-
year bond with a yield of 2.5 per cent in an
environment where inflation is running at 1
per cent carries a real yield of 1.5 per cent.
In Europe the German ten-year at 0.88 in a
zero inflation environment works out to a real
yield of 0.88 per cent. If there is 1 per cent
deflation, then the real yield goes up to 1.88
Overall, each economic zone is trying to
lower their currency against the other to try
to stimulate their respective economies. In
the process, they are trying to export deflation
and import inflation. The deflationary trend
is the result of falling demand across the devel-
oped world. That falling demand is due to an
aging demographic something which was ref-
erenced here over the past couple weeks.
The bottom line is that so long as the US
economy continues to be the best game in
town, US interest rates will remain lower than
expected and the US dollar will strengthen.
This will have an impact on oil prices.
In addition, there are views in some circles
which suggest that Saudi Arabia is actually
increasing supply now to push prices below
the cost of production for shale oil in the US
in order to "manage" the medium-term threat
that comes from new shale oil production
being brought to market.
Regardless of the reasons for the oil, interest
rate and stock market moves what is clear is
that we are at an inflection point as a result
of the US Fed bond purchase programme com-
ing to an end. That speaks to volatility and
this is exactly where we are at right now.
Ian Narine is a registered broker with the
Securities and Exchange Commission and
can be contacted at email@example.com
BUSINESS GUARDIAN www.guardian.co.tt OCTOBER 2014 • WEEK THREE
The oil and interest
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