[ihc-hide-content ihc_mb_type="show" ihc_mb_who="14,16,20,23,24" ihc_mb_template="1"] The OPEC+ meeting came across with some fun fireworks, where they announced a cut of 2M barrels a day to baseline production. The actual cut to production is much lower vs the headline, but it will result in about 750k barrels a day being cut from the current market. The below chart shows the change in the baseline from the previous target, which is WAY below for some countries but closer to actual production for others. OPEC’s actions will keep us fairly range bound on the paper market, and will also help maintain U.S. exports at about 3.7M barrels into the European markets. So far, CPC is on track to come fully back to market next week and Libya was able to export a recent record amount of crude. The North Sea also put out a loading schedule at a 13-month high with Norway pumping at recent highs. This will help offset some of the struggles on volume in the near term, but as we progress into the winter demand season it will be a competition between OPEC+ supply and global economic activity. An interesting game of chicken as inflation pushes higher around the world and global activity slows- more on that later. “Actual OPEC+ output is lagging well behind target, with combined production in September falling about 3.5 million barrels a day short of the planned level, according to Bloomberg estimates. That will dilute the impact on actual production levels of the announced cut in targets. The OPEC+ group also decide to end its monthly meetings, reverting to the previous schedule of gathering every six months to coincide with the OPEC meetings.” The below chart puts into perspective just how far below the October numbers the countries remain: Here is a quick breakdown of the “actual” cuts- 879k barrels a day. This is also assuming that countries will actually carry out the cuts. The UAE and Iraq haven’t been producing above their allotments with the UAE being the “worst” offender. We don’t expect the UAE to cut all that much (if at all) which puts the cut closer to 725k barrels a day. The cut is still sizeable when you look at the underlying market, especially as we head into the winter demand months. Diesel is still at historic lows with natural gas/LNG prices sitting at record or near record prices. Global refiners have been in turn around, but as they come out of maintenance- it will be important to see what level they come back too. When we are discussing a crude market that consumes 97M-98M barrels a day right now, a cut of 750k supply could be offset quickly with a decline in demand driven by an economic slowdown. The problem is- we are already in a recession as global manufacturing PMI data is showing a contraction. So a cut could be offset quickly by a demand drop, but we could just as easily have China reopening the country and see demand increase by 500k. This just puts us into such a precarious situation when you look at the price of the front month. We have said from the beginning of summer that prices are just “here”, and we believed that Brent prices were going to average $97-$102 in Q4. We do believe that the global consumer is going to slow down much faster at this point, but it will still take time for that to work its way through the system. The biggest overhang will be diesel shortfalls that remain at record lows- and have only gotten worse in the U.S. So far, Chinese demand between import and export quotas point to less crude demand. “China has issued ~20 million tons of crude oil import quota to private refiners, also known as teapots, in its first batch of allocations for 2023, according to domestic consultancy firm JLC without identifying its source. More than 20 teapot refiners received quotas The 1st batch for 2023, which has been released much earlier than usual, is much smaller than 2022’s 1st batch which came to 109m tons No one answered calls or an emailed inquiry at the news department of the Ministry of Commerce of China China is on holiday this week NOTE: The Chinese government controls the amount of crude imported by teapot refiners via such quotas State-owned refiners can import crude without quotas, although they need to adhere to refined product export quotas” This is very far below last year- while they still have a near record amount of crude in land storage, very elevated offshore storage, while tanker activity remains very “normal.” Based on the tanker activity below moving back to a record, there will be a replenishment on the floating storage side. The below chart looks at floating storage, which remains elevated and given the current flows will move right back to the 2021 levels. This is why it’s so important to look at how “Golden Week” is going in China. According to Bloomberg, it’s falling well short of even the most moderate expectations: “High-frequency data covering China’s National Day holiday in the first week of October douse any hope that consumption is steadying -- passenger rail traffic and cinema box office revenue plunged. A skid in home sales in the first three weeks of September added to the weak picture. Providing a positive offset, production and construction activity picked up.” “Among the high-frequency data we track, the consumption gauges were particularly weak. Cinema box office revenue in the first 6 days of the holiday plunged 65% from the comparable period last year. The daily average number of rail passengers sank 38% to 6.85 million in the period between Sept. 28 to Oct. 8, according to the official estimate.” The chart is hard to read, but you can see the trend remains in a weak pattern with some parts getting slightly worse. This will limit demand within the country, and free up more refined product for export if the government provides additional quotas. In the physical market, we are seeing some prices normalize a bit, but they started at very elevated levels. So they are just drifting down to find an “equilibrium”. Vitol reduced its offer price for Qua Iboe crude on the Platts window. Indian Oil Corp. purchased 1.9m bbl combined of Nigerian and Angolan crude from Exxon Mobil via tender. PLATTS: Vitol offered 950k bbl of Qua Iboe for Nov. 1-5 arrival on CFR Rotterdam/Augusta basis at $7.80/bbl more than Dated Brent: person monitoring window Decreased from +$8.15/bbl on Oct. 6 SONANGOL SPOT OFFER: Angola’s Sonangol offered 1m bbl of Girassol for Nov. 11-12 loading at Dated +$3.90 Reduced from +$4.50 on Sept. 30, +$6.50 on Sept. 21 Sonangol sold a separate shipment of Dalia crude for Nov. 24-25 loading, according to traders familiar with the matter Cargo was offered at Dated Brent +50c/bbl on Sept. 30 Buyer identity not immediately available The cut by OPEC+ will help support additional flows from West Africa, but we also have to consider the storage situation in the Middle East. Storage has remained well above normal, and the move to cut volumes will help the excess clear. Saudi Arabia also cut some of their OSPs, which should help move some crudes into the market as well. Even with some of these cuts to OSPs, KSA is still selling at insane premiums vs historic. The Brent vs Dubai spread is at about $6.10 so prices are still expensive into Asia but have become a bit more competitive into the European markets. This will help some flows move, but if you consider Russian flows- KSA is probably expecting a very reduced rate into Asia. There is still Nigerian cargoes “lingering” in the market, so the cut in production will support some of those cargoes to flow a bit easier, especially when you consider floating storage remains elevated in the region. The shifts in the market (talked about last week with Russia) are keeping a record amount of crude on the water. Between floating storage and in-transit, we will see flows remain at records as Russian crude flows are sustained into Asia. When we look at products, the distillate market declined further putting us in a precarious situation as we prepare for winter. The below chart shows the whole U.S. market, and we are now at the 29 year lows while PADD 1 moves even lower. PADD 1 Distillate Storage Banning the export of U.S. refined products, would only make the situation worse and raise prices for the East Coast. PADD 3 (Gulf of Mexico) is closer to “normal” and tapped out on their ability to move product into PADD 1. The options are: 1) colonial pipeline 2) Jones Act vessels 3) rail with the first option fully tapped out and the other two massively expensive. So PADD 3 can fill some of that international demand and free up the distillate flowing in from Asia/ Middle East for purchase by the East Coast. When we look at current storage around the world, we still have a glut of gasoline while distillate remains in a very problematic level. The bigger issue is the stress this puts on refiners when you look at crack spreads, because the distillate crack needs to carry the weak gasoline one. As gasoline builds, it will push down pricing making things much worse for the distillate picture. The pressure remains in Europe as gas flows remain constrained and availability of LNG dwindles for the winter months. Shipping rates are already back at record levels, and we haven’t even entered the coldest months yet. German industrial production has been slashed in an attempt to preserve natural gas, but as the cold sets in- how quickly will storage be drawn down? What happens when the economy tries to start back up? They have limited gas to crude switching capacity, and they would need to rely more on coal to produce power as they try to divert more natural gas to the retail/consumer sector. These issues are playing out all around the world as electrical grids are stressed with limited redundancy, and a natural gas market showing very elevated prices. The limited amount of gas to crude switching is going to keep pressure on the global gas markets, but even if there was capacity- the price of diesel remains very high. Central Asian countries have been unable to secure LNG cargoes due to lack of availability and/or price- and as that grows- they will rely more on fuel oil for power burn. China/India already rely heavily on coal, and if we want to get serious about climate action- we need to look at ways to bring “Stranded gas” assets to life. Adjusting these metrics will do more for our atmosphere vs the roll out of EVs. The underlying metal intensity, which takes A LOT OF DIESEL, still has to be smelted and processed which also requires a lot of electricity. And China is the LARGEST processor of all those metals, and given that 61% of China’s grid is driven by coal- most of the “green” solutions we have adopted are produced using coal. It also makes us beholden to the Chinese markets and CCP, which we already have a rocky relationship with as pressure mounts in the region. We need to get smart on the future of our policy and how we balance our grid. The problems are mounting across all hydrocarbons, and we are in a problematic position for heating oil and availability of diesel on the East Coast. I will be doing more on the shifts in the EV/ green energy universe as we need to appreciate a basket approach over the next decade. The White House is now looking to increase production of U.S. Oil and Gas, but we will need more support with pipeline construction and ability to sign deals to support the economics. Given the underlying backdrop in Europe and Asia, we have more than enough demand to allow the market to stand on its own two feet. Green technology does work in specific areas and should be included in the basket, but this isn’t an “all or nothing” solution but rather a basket. In the meantime, if we have a cold winter- WATCH OUT! Before we do a deep dive into the rates and FX world, I want to set the stage with the below chart. On the back of easy money for over a decade, we have had a PARABOLIC move higher in asset prices. We have $81T in a combination of U.S. housing and the stock market, while GDP sits much lower. This is going to be a very sloppy ending as we move through the next few years. We have called out MANY times at how the poor Fed policy is not now while raising rates, but rather the massive easy money pumped into the market over the last decade. This has put us on a course for disaster that ends with quantitative tightening that can’t be avoided, and will result in a very steep global recession. The dollar softened and rates softened a bit as the “US Job Openings By Industry” (JOLTs) data came in better than expected. This was all quickly reversed following the jobs report (as we expected). The market was positioned VERY bearish heading into this week, and the “positive” surprise has driven the market up over 2%. I think it’s important to remember the level we are sitting at in JOLTs, and a move lower is a good thing- but it is still far from a normal level. The below chart puts into perspective just how far we remain from the “normal” JOLTs setup. Labor participation rate still remains below normal, so even as job openings slow- it doesn’t mean the jobs data will worsen, which would allow the Fed to keep raising rates at an accelerated rate. The below chart puts into perspective just how far we are from “normal” labor force activity levels. We are in a very precarious time when considering the underlying market through the looking glass of rates and FX. The ADP data (which hasn’t been very reliable) saw employment additions of 208k (above the estimates of 200k), which is still showing steady growth in jobs. Nonfarms payroll confirmed the increase from ADP with an increase of 263k hobs vs the estimates of 255k. The biggest problem (supported by the chart above) is the slowdown in labor force participation. The U.S. job market has been unable to bring more people back into the workforce. This has led to broad shortfalls that are going to persist across the industry- especially as costs remain sticky. 261k individuals left labor force in September, reversal from 344k who entered in August. It is obviously only one month but it isn’t good to see prime-age labor force participation moving lower. All of these metrics are going to keep the Fed pushing forward as the data still allows them to push rates higher. Labor force participation rate (blue) down from 62.4% to 62.3%; rate for men (orange) ticked up to 68.1%; rate for women (purple) ticked down to 56.8%. Another important point to watch will be the retail side as we head into the holiday season that typically sees a strong bump. The JOLTs data had retail jobs dipping while the data in payrolls we had a bit of a bump. It will be important to see how that develops over the coming few weeks as most companies should be gearing up for the holidays. Powell has learned from the 70’s (more on that later), and he won’t be cutting any time soon. It’s still our base case that he doesn’t cut in 2023. We see rates getting to about 4.75%-5%, and instead of a cut- we expect to see the Fed holding steady at those levels. The leading data is showing the softness that will come into the jobs market and other key leading indicators, but the inflation data is still enough to keep the Fed pressing higher. This is one of Powell’s preferred methods of looking at the market, which helped cause such a powerful move to the upside. The Fed weighs some key indicators, and while the JOLTs gave a positive view on rates- it was countered by payrolls, inflation, and other key metrics (such as the PCE data). All of this supports a climbing rate situation that will keep pressure on the market. I just find it amusing that everyone said “don’t fight the Fed” when they were printing into oblivion, but now that they are raising rates- everyone wants to “fight the Fed” betting on a big pivot. We still believe the “powell put” is much lower vs the current expectations. It's a good leading indicator for the direction of the jobs data and points to a broader slowdown in jobs and the consumer. We have also seen a slowdown in the quits rate, which was unchanged in August. But- even as all of this moves a bit lower- it’s still at very elevated levels. The hope is that Powell will slowdown the speed of rate hikes, but we are still facing accelerating inflation as well as a jobs market that is still running hot. Layoffs have started to pick back up, but again you can see how far we are from the “normal” rate of layoffs. The problem remains labor force participation, which is still reduced vs normal. The below chart puts into perspective the direction of private payrolls. The problem is the data can be very lumpy, so the drop may not happen in the same aggressive move lower- but rather a more muted decline. It does point to a clear direction, which is giving the market hope that we will only get another 1% hike through year end instead of the anticipated 1.25%. When we dig in a bit more- the decline in the ratio of openings to unemployed workers so far this year has come from fewer openings, while the piece due to higher unemployment was from workers entering the labor force. Job openings plunge 1.1mn to 10.1mn: low since June ‘21 Hiring: 6.3mn (+39k) Quits: 4.2mn (+100k) Layoff near record lows: 1.5mn (+70k) So essentially, we had an easing in job openings without a significant reduction in hiring or rise in layoffs, which is consistent with the “hope” of a soft landing. We are still very early in this process, and while one data point is good- we are still very far from seeing a bigger pivot. The move this week has been driven by positioning and a very bearish bias creating the “oh so fun” bear market rally. When we take a step back and look at the data sets, there are still many red flags that have to be addressed before we see a meaningful pivot in the Fed shifts. I keep coming back to my favorite chart highlighting the issues with home prices and wages. These two key data points will need to collapse, but sending wages up to the stratosphere creates a “wage spiral” that is near impossible to manage/ control. The Fed has been tightening by selling treasuries and MBS (mortgage-backed securities) into the market. As the Fed flips from buyer to seller, China and Japan have become net sellers in the market. So now- we have the three largest buyers of treasuries over the last 30 years turning around and becoming net sellers. While volume is dumped into the market, the U.S. is still running a steep budget deficit, which requires us to roll debt as well as issue new debt. The below just puts into perspective that we are just back to our “normal” level of overspending, and I can assure you- there is NO plan to reverse to a net surplus. The sheer volume of paper in the market will keep pressure on rates, which is only supported by the Fed’s drive of rates back over 4%. The Fed doesn’t have the luxury of cutting “early” especially after the lessons learned from the 70’s. If you look at the chart below, the Fed raised rates to get in front of inflation in 1973-1974, and as inflation started falling- they decided that the trajectory was lower and started to reduce the Fed funds rate. This resulted in a complete reversal in inflation and sent us higher than the initial increase in ’73-’74. The failures at the Fed resulted in a wage spiral, and inflation spiking ABOVE the previous cycle. In order to break the cycle, Volcker took rates well above inflation and topped out around 22%. Powell is looking at the 70’s that also had supply shortages and other impeding factors (Vietnam) that created problems. By the Fed reacting “too soon”, they created another surge in inflation that was bigger and longer lasting vs the original. So even as M2 declines- there is still so much liquidity in the system that they won’t be able to just ease rates. They will have to stand firm by allowing the liquidity to drain from the market and for bond volatility and underlying asset prices to cool off. Because we have been in a QE backdrop for almost two decades- there is a lot of froth in the market that will take time to reduce. The RRP is just another example of the amount of liquidity in the market but also the amount of fear. It represents investors that would rather park money at a nominal rate (.25%) just to ensure it gets delivered at expiry. I think it’s important to look at the foreign holdings of U.S. Treasuries at the Federal Reserve. As inflation and other uncertainties mount abroad, countries and companies are hoarding more dollars. They are selling down their treasury holdings and taking delivery of USD to help protect against inflation and other shortfalls. This is also confirmed when we look at underlying spreads. There has been a prevailing view that the Fed is the one driving the dollar higher. While rates moving higher is supportive, the rate differentials are telling a different story. They would be rising sharply if the Fed was the main driver, but instead the data is showing something more muted. This is pointing more towards a weak Euro and Yen, so even if you get a dovish Fed (highly unlikely and not our base case)- the market is still going to face a strong dollar. Every new data set on FX reserves from abroad show a decline in total quantities. This is significant because we are seeing declines in key export countries: Japan, South Korea, China, and Germany. Germany has seen its trade balance evaporate as the cost of imports have surged, and demand for their products have diminished. Trade balances have shifted and as countries look to horde dollars to help offset inflation and slowing exports- the dollar strength will remain keeping pressure on the system. New orders around the world are falling, which is a leading indicator for domestic as well as international demand. It isn’t just “new orders” that are shrinking, but also “new export orders” that is putting more pressure on countries, especially the ones that rely the most on global trade. “Germany's new export orders in the September manufacturing PMI fell to 39.8 (blue), far below the 50.0 threshold and well into global recession territory. Since Germany is one of the world's leading export engines, this signals weak global demand.” When we break out the global manufacturing PMI, you can see additional drops across the board. We believe that the “pivot” has started, and the trade/manufacturing side is going to accelerate to the downside. Another key driver is the intermediate goods PMI, which is accelerating to the downside. This is a key product that transfers back and forth between entities. For example, China/India and other countries in that area typically import intermediate goods to export the final product. It’s a very important leading indicator on not only trade but also inline with global economic slowdown. As that trade slows, the weekly change in Foreign Custodial holdings and deposits keep falling. Based on the trade direction, countries/companies are going to keep liquidating treasuries and bring back USD to help shore up balance sheets. As they pull out capital, international central banks will have to repatriate capacity. Foreign central banks’ holdings of US Treasuries at the Fed custody facility are dropping fast (almost $40bn in just one week). The pressure is growing in Asia as well, especially when it comes to the flows on technology exports. Many of these exports are “high value” items, and as the drop accelerates- it will put even more pressure trade and underlying GDP growth. We are seeing a meaningful pivot lower when we look at the European and U.S. consumer. Those levels are accelerating to the downside now, which has hung in a bit longer than expected. The consumer always loves to “outperform”, but as is always the case- they start slowly and accelerate all at once. The biggest driver of it is normally how they “feel” and housing is a huge driver of it. The below chart puts into perspective just how steep the drop off has been in value with rates going up and home prices moving lower. We have also discussed that the savings rate of the consumer was being overstated, and we are clearly right now that the revisions have come through. The savings total was overstated by about $300B, and given the surge in inflation and real wages down about 5%- the cushion is being crushed. There is a rapid drawdown is only getting worse at this point, and this is a key issue when looking at the pivot lower in spending. The huge revision also changes the projects in a significant way when you extrapolate it out over a broader timeframe- the shift in excess savings $300B lower is a big problem. Other developed markets- especially Europe- are seeing a big shift down in activity based on the PMI data and underlying flows of spending. PPI is exploding higher, and the consumer is getting crushed on multiple sides. One of the biggest is the gas distribution side that is CRUSHING not only companies but also consumers. The energy intensive companies are setting more items abroad for imports as the pressure picks up across the board. This is a problem that is only going to get worse into the winter season, and it will fall on the consumer to eat a lot of the additional cost. The local governments are trying to put together “windfall taxes” that would be used to help consumers to cover the rising costs. This may seem like a great idea, but you are supporting demand by subsidizing some of these expenses. If nothing changes for the consumer, why are they going to conserve? It comes into a very murky world when we view support vs straight payments. The BoE is the perfect example as they try to raise rates, but had the federal government roll out the largest tax cuts since 1972 (there is that 70’s reference again). The money flowing through the federal government is inflationary, while the BoE is trying to shrink it’s balance sheet. They stepped in briefly for long dated Gilts, but there is only so much support that can be provided. By central banks waiting so long to raise rates/ cut balance sheets/ shrink liquidity- they now have no choice. Central banks are stuck reducing balance sheets- so even when people moan (even the UN) about raising rates- they have to understand that THEY HAVE NO CHOICE. The rates market is dictating a rise, and “the rise in interest rates isn’t the biggest blunder” rather- it was leaving rates so low for so long and supporting a bloated global economy… we made this bed… now we have to lay in it. [/ihc-hide-content] [ump-visitor] To unlock the content you need a Enterprise Account! [/ump-visitor] [ump-logged-user] This content is visible only for Enterprise Account! [/ump-logged-user]