Focus: Historic deal amid contracting economy

Analysis Focus: Historic deal amid contracting economy
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Updated 13 April 2020

Focus: Historic deal amid contracting economy

Focus: Historic deal amid contracting economy

What happened:

During the first quarter, stock markets incurred losses not seen since the financial crisis. They displayed healthy gains in April, but volatility was high throughout, with the volatility index reaching historic highs surpassing the 80 percent mark.
On Monday, stocks fell in Asia’s major financial centers and by mid-morning, US futures were down too. Investors are waiting with bated breath for earnings season amid the economic uncertainty due to the coronavirus disease (COVID-19) pandemic. Europe is closed for Easter Monday.
According to the Brooking FT tracking index, the global economy will be facing its worst quarter since the Second World War, as many Organization for Economic Cooperation and Development (OECD) economies have ground to a halt and jobless claims are at unprecedented highs throughout all major economies. In the US, 17 million have lost their jobs in less than a month. This is particularly serious because 70 percent of the GDP in the world’s largest economy is attributed to consumption. Irrespective of major stimulus packages, targeted at business and individuals alike, we can expect a flurry of bankruptcies throughout the OECD world. Small and medium enterprises  (SMEs) will be hit particularly hard because they do not have the resources and wherewithal of big corporations. This is bad news because SMEs employ up to 70 percent in many economies including the US. The International Monetary Fund (IMF) Managing Director, Kristalina Georgieva, informed that 170 out of 189 countries across the developed and developing world will suffer from falling output in 2020.

Against that backdrop, it was particularly important that OPEC+ could finally reach a historic agreement to cut 9.7 million barrels per day (bpd) for May and June. The amount will be ratcheted down to 7.7 million bpd until the end of the year and to 5.8 million bpd from Jan. 1 next year until April 30, 2022.
US President Donald Trump, not a friend of OPEC under normal circumstances, hailed the deal as saving hundreds of thousands of jobs in the US. Initially the oil price reacted positively, with Brent gaining more than 5 percent on the news, but then plummeting more than 7 percent from its intraday high. By early afternoon CEST, Brent had lost 0.1 percent on the day, standing at $31.45.  

Why it happened:

The April gains in the stock market can in part be explained by the unprecedented stimulus packages injecting cash and temporary confidence and in part by the fact that many institutional investors have allocation guidelines for asset classes. After a dismal first quarter, they needed to bring the asset allocation closer to the prescribed percentages. That only explains part of it. Volatility suggests that nervous investors were at a loss as to where to direct their cash.
The OPEC deal was necessary. The sector suffered from a demand shock anywhere between 20 and 35 percent if not more. This was exacerbated by a supply shock where Russia and Saudi Arabia pumped crude into the market in a quest for market share. The politics behind the deal were complex. Trump intervened by talking to Saudi Crown Prince Mohammed bin Salman, Russian President Vladimir Putin and Mexican President Andres Manuel Lopez Obrador. In the end Saudi Arabia, Russia and some other Gulf Cooperation Council and OPEC producers are taking the main share of the pain. Since 2003, Russia’s production has not been as low as it will be beginning of May. G20 economies outside of OPEC+ will produce around 5 million bpd less, alas not via cuts but via natural attrition due to falling demand.

Where we go from here:

The IMF will hold its virtual spring meeting this week. It will release its latest forecast, expected to show the deepest contraction in the global economy since the Great Depression. Expect that forecast to reverberate through the markets.
The OPEC+ deal, while historic, will probably not be sufficient. It gives some respite and extends storage capacity. However, we should not expect oil demand to recover drastically over the next two months at least, which will leave the world with a huge supply overhang.

— Cornelia Meyer is a Ph.D.-level economist with 30 years of experience in investment banking and industry. She is chairperson and CEO of business consultancy Meyer Resources.
Twitter: @MeyerResources