Analysis

Investors switch focus from trade to fundamentals

Equities in Asia received a boosttoday, as a result of higher commodity prices and strong U.S. earnings announcements. Energy and mining stocks are leading the gains this morning, as Brent and WTI traded at their highest levels since late 2014. Oil found support after data from the Energy Information Administration showed that crude inventories dropped 1.1 million barrels in the week to 13 April, while gasoline and distillate stockpiles fell by more than 3 million barrels. Now it is OPEC and Co.’s turn to capitalize on the bullish report as they meet in Jeddah on Friday.

While the elimination of oversupply has been a critical factor pushing oil prices, I still believe there’s a significant risk premium being priced in, specifically the fear of supply disruption from the Middle East and possible renewed sanctions on Russia and Iran. Although OPEC may send signals of extending the supply cut deal, I think a target price of $80 to $100 is unrealistic. U.S. Shale now has more incentive to boost production,especiallysincethey can hedge at very attractive prices. Now, we can expect U.S. output to exceed 11 million barrels sooner than expected.

Base and precious metals also rose strongly, pushing the CoreCommodity CRB Index to itshighest level since mid-2015. Should central banks be worrying about being behind the curve when it comes to inflation? Next month, we will probably get to know the impact of rising commodity prices on consumer inflation.

While the rise in commodities and robust earnings send positive signals to investors, fixed income markets are sending opposite signs. The U.S. yield curve has been making headlines for some time, and the yield between 10 and 2-year treasury bonds shrank to 41 basis points yesterday, the lowest since 2007. If the yield curve inverted within sixmonths, as St. Louis Fed President James Bullard suggested, it will be an indication that a chance of a recession becomes very likely. This is happening at a time when global debt is at historic highs, according to the IMF. Total debt reached a record $164 trillion last year.

In currency markets, Sterling will attract the most attention, after disappointing economic data pulled GBPUSD from its highest levels since the Brexit vote. While wage growth data supported the chance of a Bank of England rate hike, yesterday’s Consumer Price Index report showed there’s no need to hurry. If today’s retail sales badly disappoint, I think there’s a high chance that the BoE will postpone the rate hike until June, suggesting that Sterling could see further declines towards 1.40.

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