Energy

CCP officials are discussing policy options for breaking out of a deepening liquidity trap. Anything policymakers come up with will be additive to existing spending and to the multi-trillion-dollar fiscal-stimulus packages being rolled out by the EU and US. Inflationary pressures in the real economy will become embedded as increasing demand for industrial commodities meets constrained supply. Stagflation likely follows.

Systematically important central banks continue to compound policy errors, which will feed higher headline inflation. Hiking interest rates to induce labor-market slack – i.e., higher unemployment – to bring down core inflation will reduce demand for scarce commodities as incomes fall. It also will increase the cost of conventional and renewable capex and slow the final-investment-decision (FID) process. Net, supply will tighten as demand is squeezed. This will resolve itself in higher volatility and prices. Separately, we were stopped out of our XOP and XME ETFs spanning energy and mining equities, respectively, with a loss of 11.9% and a gain of 4.4%. We will be re-establishing these exposures at tonight’s close.

China’s victory in getting KSA and Iran to restore diplomatic relations is of far greater consequence to commodity markets than the past weeks’ bank failures in the US. For China, further success in sorting long-standing security issues in the Middle East could incentivize oil and gas capex and affect oil flows. With short- to medium-term fundamentals largely unchanged, we are keeping our 2023 and 2024 Brent forecasts similar to last month, at $95/bbl and $110/bbl, respectively.

Bank failures are another ‘canary in the coal mine’ warning that a US recession is imminent, yet stocks, bonds, and the oil price are still a long way from fully pricing it.

The development of trading blocs and the rise of economic warfare will lead to the inefficient allocation of resources. Higher fiscal outlays and tight commodity supplies will feed into energy prices driving headline inflation. It also will drive demand for inventories as hedges against supply volatility globally higher. We remain long equity exposure via ETFs to oil and gas producers, and metals miners. We also retain our exposure to commodities via the COMT ETF.

Central Banks remain in thrall to the mistaken impression that backwardated oil futures markets are signaling lower headline inflation over the next 2-3 years. This is not the signal the markets are sending: Backwardation is an indication inventories are being drawn down to cover a physical supply deficit brought about by strong demand. We remain long broad equity-market exposure to energy producers via the XOP ETF, and to outright commodity exposure (and backwardation) via the COMT ETF.

China’s housing market adjustment will be protracted, causing several years of sub-par growth in the world’s second largest economy. We go through the major investment implications.

Global demand for new energy vehicles (NEVs) remains in a long-term uptrend, propelled by falling battery prices, improved driving range and an upgraded charging infrastructure. That said, diminishing policy support in China and Europe will spark a drop in the growth rate of global NEV sales to about 35% this year, down from about 60% last year. Global NEV-related stocks are likely to rise on a structural basis, but we recommend that investors wait for a better entry point given that valuations remain high.

The rebound in growth is pushing up inflation. More aggressive monetary policy is likely to trigger recession over the next 12 months or so. Investors should stay defensive.

Investors should avoid / stay underweight Turkish stocks and local currency bonds versus their respective EM benchmarks. Stay underweight Turkish sovereign credit.