Second Time Around

Second Time Around

With plentiful oil stocks still holding down prices, OPEC, Russia and a coalition of smaller producers agreed to extend production limits for another 9 months; world trade volume jumped higher; markets shrugged at Moody’s China’s debt downgrade.


“Trade [is] part of the solution to economic difficulties, not part of the problem.”
World Trade Organization Director-General Roberto Azevêdo

Oil – second time around Despite the agreement brokered by OPEC among 24 oil producers last year to hold back production, oil prices have not moved substantially higher, thanks largely to the resurgence of US shale oil production. With global oversupply persisting, the group agreed last week to extend its deal another 9 months, in the hope that stockpile reductions already in progress will begin to bite.   While the agreement does cover Russia, a major non-OPEC producer, many others, including the U.S., Canada, Norway and Brazil remain outside the deal.

World trade – revival mode The total volume of world exports and imports grew 1.4% in 1Q 2017 versus Q4 2016.1That’s welcome news for the world economy in 2017; weak global trade volume in 2016, up only 1.3% for the year, was a factor in the sluggish state of the global economy last year. In contrast, the World Trade Organization (WTO) forecasts global trade will grow 2.4% in 2017—but that projection is contingent on no new trade restrictions and/or tightening of monetary conditions. Better growth in emerging markets this year is helping bolster trade and nascent signs of stronger investment in plant and equipment, i.e. capital expenditures, could provide an additional boost to trade, according to the WTO.

China debt – moody blues Financial markets were caught off guard when Moody’s downgraded China’s sovereign debt rating to A1 from Aa3—the first downgrade of China’s debt by Moody’s since November 1989. Stocks in China and international commodity prices both fell immediately after the announcement, but quickly rebounded off the lows. China’s Ministry of Finance said on its website that Moody’s decision underestimated the capability of the government to deepen supply-side reform and boost demand.

China’s GDP grew 6.9% year over year in 1Q17—one of the fastest growth rates in the world. However, Moody’s appears concerned about a continued rise in China’s debt level combining with slowing growth in the years ahead as the country transitions toward a domestic-consumption economy from an export-oriented one. The central bank has raised interest rates twice since February and there’s very little difference between the yields of 2-year and 10-year sovereign bonds, a relationship that can signal slowing growth. Of course, China has numerous policy levers available to respond, which may help explain why markets have taken the latest developments in stride.

U.S. housing – April showers April was a gloomy month for the U.S. housing market, but analysts still see brighter days ahead. In April, new single-family home sales declined -11.4% and existing home sales fell -2.3%; housing starts also dropped by -2.3% and building permits declined -2.5%. Yet economists noted the monthly volatility inherent in housing statistics, viewing April’s weakness as a temporary aberration. Homebuilders don’t seem concerned either. A leading gauge of homebuilder optimism2 reached 70 in May—a level not seen since 2005.

Several positive trends should support housing demand. Employment gains continue and wage growth should continue to follow as well. In April, the employment of Millennials—who are reaching prime home-buying age—grew 3% from a year earlier relative to just 1.1% for all other age groups. In addition, mortgage rates remain low and the homeownership rate remains depressed in part because more people have chosen to rent than buy in recent years. That could be changing already—buying a home rather than renting was more popular in the first quarter than in any quarterly period in more than a decade.

U.S. Fed – Minute by minute  Despite slower than expected growth in the first quarter and subdued inflation expectations, the U.S. Federal Reserve (Fed) appears almost certain to follow through on what’s widely expected by the markets; a 25 basis point rate hike at its mid-June meeting. That’s the current consensus interpretation of the minutes from the Federal Open Market Committee (FOMC) meeting held earlier this month, which stated that “most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation.”

A June hike would lift the federal funds rate to a range between 1% and 1.25%, a level not seen in almost 9 years. The minutes also suggest a consensus is building to begin shrinking the amount of Treasury and mortgage securities held in the Fed’s portfolio later this year, by tapering reinvestments and setting limits (to be periodically adjusted higher) on the dollar amounts that would roll off its balance sheet each month.


Sources: Bloomberg, Wall Street Journal, Legg Mason

1 The Netherlands Bureau for Economic Policy Analysis reports global trade volume

2 The leading housing optimism index is The National Association of Home Builders (NAHB) Housing Market Index 

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