Global Disinflationary Winds Blow Hard

The carnage for the hydrocarbon complex is showing no signs of abating, with both WTI and Brent hitting fresh cycle lows this morning.  The supply and demand function for commodities has been touted as the main catalyst for triggering the flush in oil price action, as sticky, higher-cost supply has been unable to react to waning global demand. Not as widely acknowledged in the financial media has been the extent at which crude has become one of the most ‘financialized’ commodities, and the 50% haircut over the last year has sparked a wave of stop-loss selling from money managers capitulating on their long-crude bets.  We would argue that while the continued decimation of commodities will translate into short-term pain for North American GDP as rigs closures and employment losses weigh on economic growth, stabilization in oil prices are key to supporting both investor and consumer confidence.

In addition, the supply and demand function might not be as dire as one is expecting, as China posted optimistic trade balance numbers overnight for the month of December. Exports rose by 9.7% versus estimates of a 6.8% increase, while imports fell by 2.4%, slower than the 7.4% contraction that had been forecast.  The overall trade surplus came in narrower than expected due to better than forecast import volume, though the silver lining for commodity exporters was that China took advantage of the decline in crude prices and snapped up the largest monthly volume of oil on record, an increase of 13.4% from the corresponding month last year.

Whether the up-tick in demand for crude from China is an opportunistic purchase, or demand might not be slowing as much as anticipated, these numbers will be important to follow in the coming months.  The data has done little to impede the wash-out in energy, with front-month WTI falling below the $45 handle, and thus putting pressure on the loonie with USDCAD making an attempt at overtaking the psychologically important 1.20 level.  While we expect there to be decent barrier defense at the 1.20 handle for USDCAD, the failure for oil to stabilize itself and continue its decline will likely aid USDCAD in its push higher.

The oil rout has also sparked concern over deflationary forces on a global basis, as witnessed last week by the eurozone, and again today as inflation figures for the UK missed expectations by a wide margin and will force Governor Mark Carney to write an open letter explaining why prices have dropped below the 1.0% threshold on an annualized basis.  Falling energy and food prices weighed down the headline reading to print at only 0.5% in December, down from the 1.0% increase registered in November, and the 0.7% pace economists had been expecting.  The disinflationary pressures are likely to help Carney keep his dovish majority on the Monetary Policy Committee, justifying the current level of monetary stimulus until at least the end of 2015.  The ongoing revisions to when the rate tightening cycle in the UK will begin has lopped off over 12% of the pound’s value against the greenback when compared to the middle of 2014, with market participants now expecting a rate tightening from the BoE not to emerge until early 2016.  The pound is essentially unchanged against the big dollar in the high-1.51s as we head into the North American open, but today’s inflation reading serves to underscore the disinflationary pressures felt on a global scale, and how monetary policy will continue to diverge between the Fed and the rest of the developed world.

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