Global Economic Highlights

It has been quite a busy period of central banks' policy stances and we have heard a bit from ECB, Fed and BoJ recently. The ECB talked about corporate bond purchasing program with the general feeling that it exceeded expectations. The Fed made some changes to its language obviating the external risks but the market response remained mostly unconvinced pertaining to the next tightening move. Finally, while the investors were expecting some action from BoJ, the market's reaction was an obvious disappointment. This can be portrayed as a case of mismanagement of expectations.

After the BoJ's announcement, markets were eyeing on the US data and particularly the Q1 GDP result. The growth number of +0.5% qoq was disappointing as the expectations were at +0.7%. This is due to the reduction in business fixed investments. The inflation data released gave an upside to USD strength and the Treasury yields. The Q1 Core PCE came out at +2.1% qoq which is the highest level achieved in last 4 years. It can be inferred that any near term strength in core inflation is going to be temporary because the residential rents' growth and the rate of health care spending is slowing which forms a large chunk of the core PCE deflator.

The Employee Cost Index (ECI) released earlier this week showed a mildness in worker compensation. This is a good enough evidence of a very little relationship between unemployment rate and wage growth. The Phillips curve is in doubts again!

Oil Story: Would production freeze be an effective move?

If oil producers had agreed to freeze oil supply at a January level until October 2016, this wouldn't have much meaning for market fundamentals because the prospective agreement would have excluded both Iran and Libya which are the only countries with a production growth potential in the short term. Let us see the positioning and rationale below.

Iranian production averaged 3.30 mmb/d in March, up from 2.91 mmb/d in December 2015. The government believes that the production level of 4.00 mmb/d can be achieved by March 2017 but the growth may be limited by primary US sanctions which still holds their place. These US sanctions are meant to target Iran's support for terrorism, creation of weapons of mass destruction, the avoidance of human rights in both Iran and Syria. They restrict US companies and individuals to transact with Iranian financial institutions which results in marginal dampening of exports from Iran.

Another major development that will potentially pave a way for enhanced joint venture investments with local companies in Iran is the revised formulation of Iran Petroleum Contract (IPC). The revised terms of the IPC appears to be improved as it includes no capex ceiling and the cost overruns are no longer to be suffered entirely by the participating International company. Also, the remuneration will be floating based on oil price, and will allow the international company to participate in any excess production over and above the agreed target level. The duration of contract has also been revised to over 20 years. These revised terms would be beneficial to attract both foreign capital and technology to successfully exploit the upstream oil and gas projects.

The production in Libya is at its 12 months low of 340 kb/d down from a level of 1.4 mmb/d. There has a huge damage to oil exporting and transportation infrastructure which in turn has affected its capacity. The further production outlook for Libya depends on government's success in restoring peace and order which right now appears to be more remote.

The rift between Saudi Arabia and Iran turned a potentially positive event into a negative creating a suspicious outlook for any potential agreement in June's meeting. While the oil producers were meeting in Doha, there had been an open ended strike of oil workers in Kuwait over the issues of salaries and benefits which has resulted in a significant reduction in oil production. This level of reduction could neutralize the bearish impact of the failure of meeting in Doha if at all it could last long enough.

Last week's US petroleum statistics were positive for the market as the supply fell just below 9mmb/d level for the first time since October 2014. For the last two weeks, the change in Brent positioning has been driven more by an increase in long positions rather than a reduction in shorts. The heightened long positioning and the likelihood of a floating storage unwind threaten to pressure prices in near term.

Pending drawdown could pressure prices lower; Source: Bloomberg