On oil's big drop and central banks

2 min read
Divyang Shah

We have had a continuation of the fall in oil prices on Wednesday with December Brent off another 1%. After the weaker-than-expected inflation data from the UK and Sweden on Tuesday, we have had weak prices data from China with PPI at -1.8% (exp -1.6%, 2.0%) and CPI at 1.6% (exp 1.7%, prev 2.0%).

Worries over global disinflation are building and this is visible on the continued fall in 5y5y inflation swaps in for EZ and 5y5y breakevens in the US.

Thus far, a real response from central banks has been lacking, with the ECB still relying on implementing its June/Sept easing measures while the BoE/Fed hint at the prospect that weak growth abroad would have implications for the rate outlook.

There is no scramble to arrest the deterioration in market sentiment which seems related to an adjustment in too optimistic expectations over:

1) global oil demand and

2) the reaction function of Saudi Arabia.

For now it’s a matter of taking risk off the table and waiting for:

1) the market and oil prices in particular to stabilise and

2) for greater clarity from the Fed/BoE/ECB.

We have been biased toward holding bonds for sometime especially as a hedge against risk and a proxy for long vol but the dangers are that the market is currently overextended.

Below is how the Brent curve has shifted since the Sept FOMC meeting:

Brent

Source: Thomson Reuters

Brent PPB