Perspective: Morning Commentary, 02/16/2016

Tuesday, February 16, 2016

February 16 – The markets are breathing easier this morning as global economic concerns ease; at least for now. The problems still exist, but the markets are a bit more confident that intervention will reduce risks, at least in the near-term. European Central Bank Chair Mario Draghi commented Monday that the ECB is fully prepared to utilize additional easing tactics to shore up the European economy. The European Central Bank meets again the first week of March to consider changes to its monetary policy. Furthermore, the world’s two largest producers of crude oil agreed to a production freeze; that is if other major producers agree to participate as well.

The dollar has been in a free-fall since February 3, but gapped higher on the charts overnight. Gains in the euro softened following Draghi’s comments and the explosive run in the yen seen this month as traders unwound carry trades appears to have halted for now. Japan reported Monday that its economy contracted by 1.4% in the fourth quarter, which was even worse than market expectations of a 0.8% contraction. That suggests even weaker fundamentals for the yen going forward. As such, the dollar has freedom to rally again, based on its relatively stronger fundamentals compared to these other two major currencies.

Additional support for the dollar comes from a softer yuan today. China’s currency boasted its biggest one-day surge in more than a decade Monday, but is backing off today. China took steps to boost spending and is looking at ways to encourage lending by banks to stimulate the economy. The government is providing more money for local infrastructure projects to create jobs, while China’s cabinet discusses lowering the minimum ratio of provisions that banks must set aside for bad loans. That should free up money for good loans and improve the books for the banks. The move comes as data shows that new credit in China surged to a record 3.42 trillion yuan ($525 billion) as property values recover, reflecting better consumer sentiment within China.

Russia and Saudi Arabia agreed to freeze crude oil production at record high January levels on the conditions that other major players agree to do so as well. That becomes the main sticking point, as rival Iran would likely to re-establish its market share following the lifting of sanctions before agreeing to a freeze. There is some talk that Iran may be given special conditions to reach an agreement.

West Texas Intermediate crude oil rallied to $31.53 on the news, but has since gave back its gains. A freeze at January levels would still leave production at levels threatening storage capacity. There remains skepticism that an agreement can be reached without providing special conditions to Iran that would boost production further. Finally, there are good reasons to be skeptical that the agreeing parties would actually live by the agreement due to a history of cheating. There is very little trust among several of the major producing nations.

Money flowed into the broader commodity sector early today, led by hopes that crude oil could hold the friendly double-bottom on the charts with a production freeze in hand. However, that money flow has reversed this morning as crude oil pulled back as market skepticism rose again, with added pressure from the stronger dollar. Grain and oilseed prices posted impressive gains overnight, but that strength began to wane when money flow reversed for the broader commodity sector, led by crude oil. The grains have at times this month shown signs of wanting to build risk premium ahead of the approaching growing season, but still struggle under ample supplies and the lack of a legitimate threat to this point. As such, efforts to add risk premium continue to face stiff headwinds as long as crude oil fails to confirm a bottom.

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