REPORT
By Övünç Kutlu
U.S. letter, week beginning Oct. 3

 

What happened last week?

The most important development last week was OPEC’s decision to trim its total production, which had a positive effect on the U.S. stock market and caused increases in indexes.

OPEC decided in an unofficial meeting last Wednesday in Algiers to cut down its daily crude oil output to 32.5 million barrels, down 750,000 barrels a day from its average production in August. However, the cartel said it would wait until its biannual meeting on Nov. 30 to finalize the deal. If realized, the plan would be the first time the cartel has taken action against plummeting oil prices since they first began falling in June 2015 from the $115 per barrel level.

If implemented, the plan is expected to trim the glut of supply in the global oil market and push oil prices up. But experts and analysts have already raised concerns about the successful implementation of the deal due to various misgivings.

Firstly, OPEC did not remain faithful to its official production quota over the previous months. During the period when the official quota was 30 million barrels a day, the cartel produced above this level, and heightened mistrust in the organization.

Secondly, the new deal suggests that Nigeria and Libya be exempt for making individual production cuts. This means that heavyweight Saudi Arabia has to carry the burden for those countries by limiting its own output. However, given Riyadh’s long-term strategy of raising its production level to at least maintain if not increase its share in the global crude market, it is unclear how much burden the Saudi government is willing to carry.

Thirdly, Saudi Arabia also faces the risk of continued increase in Iranian production. Iran is not only a political rival in the region, but Riyadh perceives Tehran as a challenger to its high level of influence within OPEC. Iran is adamant about increasing its crude output until it reaches the pre-sanctions production level. So, it is still unknown how much production cut Tehran will agree on.

The fourth concern is the willingness of Russia to trim its own output. The country is not an OPEC member, although Moscow has said numerous times that cooperation with the cartel is a must to find a balance for prices in the global market. But, it will remains to be seen to what extent the country will cut down its production until after OPEC’s plan is finalized.

The fifth and finally point is that an OPEC cut would trim the global supply in the short-term and raise crude prices. However, this would be enough incentive for the U.S.’ shale producers to bring in additional rigs and pump more oil into the market. Therefore, the OPEC deal could result in shale producers filling the void in the market in the long run if prices climb and stay above $60 per barrel. Many experts already refer to shale oil as the “swing producer” because they can quickly ramp up or trim production based on prices and supply in the market.

With the OPEC deal and anticipation that oversupply will be trimmed, the price of crude oil jumped around 6 percent last Wednesday and continued to increase over the next two days. As a result, the U.S. stock market also posted gains.

On a weekly basis, all the indexes in Wall Street ended with increases. Moreover, the American stock market had seen its most profitable quarter of this year during the months from July through September. The Dow Jones rose 2.1 percent, the S&P 500 gained 3.3 percent, and the Nasdaq soared 9.7 percent in the third quarter of this year.

The gain in tech companies’ share values particularly played a role in this performance. However, some analysts warn that such increases in tech stocks could be misleading, cautioning on a potential bubble and then a sudden decline. They suggest investors wait for the third quarter net income and revenues of tech companies which will be announced this month.

 

What to expect from this week?

This week, investors will weigh the likelihood of implementation of OPEC’s deal and will take their positions in the oil market accordingly. Any positive signal from Saudi Arabia, Iran and Russia would increase the likelihood of the successful implementation of the deal at the end of next month, and could send prices up again. However, any negative signal or the revival of the Saudi-Iranian struggle in OPEC could raise suspicion that the deal could fail and push prices down. 

Meanwhile, incoming macroeconomic data has become more important than ever since the Federal Reserve only has two meetings left this year to make a rate hike – in November and December. Every piece of data showing the current conditions of the American economy will be dissected carefully by the Fed officials, investors and the markets.

The most important data this week, which the Fed also gives a lot of importance to, will be the non-farm payrolls and unemployment rate for September to be announced on Friday.

In August, non-farm payrolls came below expectations as the economy added only 151,000 jobs. While the average over the last three months is still strong, closer to 200,000, if non-farm payrolls come closer to the market expectation of 170,000, this would take the Fed one step closer to make a rate hike. Meanwhile, the unemployment rate stood steady at 4.9 percent in August and is not expected to change for September.

If these two statistics come in either as projected or better than expected, the stock market could suffer losses on Friday with the increased possibility of a Fed rate hike.

One major problem for the U.S. stock market in recent months has been investors focusing too much on the likelihood of a Fed rate hike, rather than the positive data showing the overall wellbeing of the economy. Experts stress that since the Fed has not raised its benchmark interest rate in six of its meetings this year and only has two meetings left in 2016. Therefore, investors have become more vulnerable to a sudden rate hike and are scrutinizing every move the Central Bank is making and are watching more closely how its officials are interpreting the macroeconomic data.

 

05 Oct,2016

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