Oil: Non-OPEC Production Declines

Oil markets will continue to be buffeted by Russian overtures to OPEC suggesting a desire to orchestrate a production cut. Uncertainty over the Fed’s next move will keep markets on edge. Markets are rebalancing, nonetheless, and prices are bottoming.


Even though Russian oil production remains at post-Soviet highs, it has been declining slightly month-on-month since mid-2015, and started posting yoy declines in the fourth quarter.

In addition to Russia, other non-OPEC producers will see meaningful production losses this year. Noteworthy among this group are North Sea producers. Oil output in the North Sea took a turn lower in 2015Q4. We expect low prices will force production lower this year and next, in line with the EIA’s forecast of 2.75 mm b/d this year, or about 250 kb/d yoy.

Overall our commodity strategists expect non-OPEC oil (crude and condensates) production to fall yoy by close to 1.7 mm b/d in 2016. This is higher than the EIA’s estimated 640 kb/d production decline for non-OPEC. In our projection, we see sharply lower U.S. production – please see the next Insight, (Part II) Oil: Sharply Lower U.S. Output Expected.

The U.S. Dollar Shortage

U.S. dollar liquidity, calculated as the U.S. monetary base plus the amount of U.S. government securities held in custody for foreign accounts, is shrinking.


Curiously, this U.S. dollar liquidity measure is presently contracting faster than it did during the Asian/EM crises in 1997-’98.

Both components of this measure are weak. The U.S. monetary base is shrinking as U.S.-domiciled banks’ reserve balances at the Federal Reserve are contracting. Meanwhile, foreign holders of Treasurys are selling their U.S. bonds and notes as demand for the greenback is surging. This is likely related to EM central banks’ intervention in their exchange rate markets to defend their currencies.

Historically, this measure of U.S. dollar liquidity has been correlated with EM share prices, and somewhat less so with advanced countries’ share prices. Our EM team believes shrinking U.S. dollar liquidity will be accompanied by a rising demand for U.S. dollars, especially from developing countries. This will ensure the U.S. dollar’s value is bid up further, particularly versus EM currencies.

Please see the next Insight, (Part II) The U.S. Dollar Shortage.

U.S. Equities: Does It Still Make Sense To Favor Growth Over Value?

Our U.S. equity strategists argue that the parabolic rise in the growth vs. value trade has run its course and is no longer sustainable.


The bulk of our style Indicators shown in the chart above signal that macro conditions are still tilted in favor of growth. As a reminder, growth indexes almost always move to a premium when economic growth declines, as is currently the case.

Perhaps the most powerful tailwinds for the growth bias relate to the deflationary backdrop. Growth indices have a better track record than value indexes when pricing power is ebbing. Even then, our relative pricing power proxy is soaring, further reinforcing that growth stocks have a meaningful profit advantage.

Growth margins are consistently higher and have less cyclicality than those of value firms, underscoring that when overall sales are pressured, growth earnings should be more stable. The latter explains why the growth vs. value price ratio is positively correlated with broad market volatility. With the VIX index moving sharply higher, it is no wonder that the share price ratio has gone vertical.

Nonetheless, our U.S. equity strategists are losing conviction in the ability of growth stocks to sustainably outperform from current levels, despite our downbeat view of global economic growth prospects. Please see the next Insight, (Part II) U.S. Equities: Does It Still Make Sense To Favor Growth Over Value?

How To Play Fresh ECB Easing

The plunge in oil prices has raised the risks that the ECB will not hit its inflation target, even with European growth showing solid upside momentum. Additional ECB easing measures are likely in March. What are the best ways to play for additional ECB easing in European fixed income markets?


Our global fixed income strategists don’t think increasing core duration exposure is the way to go. Longer-dated yields in Germany and France are already at very overvalued levels and the experience of the sharp German Bund selloff last April highlights the risks of extrapolating yields to zero, even during a QE program.

Putting on curve trades (like a bull flattener) in core Europe is also not advised, given how directional the yield curve has become with the overvalued level of yields. Inflation expectations should be expected to widen in the event of more ECB easing, but the path of CPI swap rates and inflation breakevens will still be determined by the trajectory of oil prices in the next few months, making inflation trades a risky bet.

We think that any new easing measures will most likely benefit Peripheral spreads the most – please see the next Insight, (Part II) How To Play Fresh ECB Easing?

Ten Investment Themes For 2016

Our Global Investment Strategy service recently published their Annual Outlook, which discusses the ten themes they expect to drive global financial markets throughout the year:

Theme #1: U.S. Growth Continues To Disappoint
The U.S. economy is likely to underwhelm, prompting the Fed to stand down from its ill-conceived plan to raise rates four times this year.

Theme #2: Euro Area: The Calm Before The Storm
The euro area continues to benefit from a weaker currency and a loosening in bank lending standards, but these tailwinds will ebb later this year.

Theme #3: Japan: Treading Water
Efforts by Japanese policymakers to bring inflation up to 2% look increasingly elusive. Ultimately, some degree of debt monetization may be necessary to reflate Japan’s economy.

Theme #4: Emerging Markets: Out Of The Frying Pan And Into The Fire
The situation in many emerging markets is dire and could get worse as flagging growth causes financial stresses to surface.

Theme #5: The Call Of The Trumpists Reverberates Around The World
Globally, the political backdrop remains fraught with uncertainty, not just in the usual hotspots such as in the Middle East, but increasingly in developed economies as well, where populist politicians are finding a receptive audience for their message.

Theme #6: Safe-Haven Bond Yields Remain Depressed
One of our highest conviction calls over the past few years has been that safe-haven bond yields would stay depressed, even in the face of the tentative economic recovery in much of the developed world. Treasury yields could drift higher over the next few months, as the Fed starts to prep the market for a second rate hike, but we ultimately expect the 10-year yield to finish the year at around 2%.

Theme #7: Credit: Too Soon To Enter The Junkyard
Last year’s selloff in high-yield credit has made this asset class more attractive from a valuation perspective. However, with U.S. corporate balance sheets still deteriorating, spreads could continue to widen.

Theme #8: Global Equities Struggle To Defy Gravity
The Global investment Strategy service downgraded global equites from overweight to neutral last month, after having been overweight this asset class since April 2009.They continue to favor DM over EM equities and defensive sectors over cyclical ones. Within the DM equity universe, they have a modest preference for the euro area and Japan over the U.S.: The Fed is hiking rates, U.S. stocks are considerably more expensive, and there is less scope for profit margins to increase. Within EM, they advocate avoiding countries such as Brazil, South Africa and Turkey, which are vulnerable to sudden stops in capital flows, preferring instead economies such as China, which have the policy tools to deal with weaker growth.

Theme #9: Commodities: The Bear Market Persists
While a variety of geopolitical developments could give crude prices a temporary lift, ongoing technological progress in shale will continue to push down breakeven costs, and ultimately, prices. Likewise, rising mining supply, combined with China’s transition to a more service-oriented economy, should cap any rally in bulk and base metals. Gold will remain in a prolonged bear market.

Theme #10: An Increasingly Narrow Dollar Rally
The dollar will continue to strengthen this year, but mainly against EM and commodity currencies.

Clients interested in reading the full report can access it here.