Another rather wild night of price discovery as further data out of China reinforced the slowing concerns that have sparked a modest sell off in the equities and fixed income yields. The question now becomes whether this is a pandemic situation that deepens not only in China but throughout the Far East and into Europe. At some point the global economy has to reassess its dependence on an explosive economy in China. With a GDP of over 7% the second largest economic power globally remains robust, though not at the rate that the world has become accustomed to over the past decade. While there is certainly concern over China's lagging export market and her less than stellar industrial data of late, how that effects the US economy is not so certain. Companies with exposure to the Yuan and/or Chinese exports could see some slippage, as could energy and other commodity dealers, yet the pull back in the once stalwart economy of China could and should spell vast opportunity, particularly for US industry that is continuing to show strength in the face of global concerns.
The flight to quality in the fixed income market is part panic and part the idea that a depreciating Yuan would somehow keep our Fed from taking action on rates that they deem necessary based on US data. It would seem to be a bit of a stretch that this modest move by the Chinese (this 'devaluation’ was really less significant than the markets are pricing in as it is more about how the market is settled on a daily basis rather than a harsh slashing of the valuation of her currency) would reverse the mindset of the FOMC intent on normalizing the US rate picture.
Energies have the most to be concerned with when looking at the slowing Chinese economy. However, at these already depressed prices it is probably fair to say that this event is well priced in to the crude oil and refined product markets. In fact, the IEA report last evening stated unequivocally that demand, even with the state of Chinese affairs, is soaring at a pace unseen in the past five years. While that demand is offset to some extent by continued production leading to oversupply, it is again to consider that this excess is most probably priced in with the WTI crude market trading in the low 40's.
It is interesting to note that the declining crude market has featured more rapid selling in recent days in the WTI contract when comparing it with the Brent crude contract. At the start of this most recent decline it was noted that most of the bearish fundamentals were more particularly aligned with the Brent crude contract (Iran, European concerns, China slowing, etc) and the price discovery of the spread between the two largest crude contracts reflected that sentiment. At the onset of the sell off from 60 dollars the spread was about 6.50 Brent over WTI. During the decline to 45 dollars we witnessed the spread tighten as expected to, at one point, just under 4 dollars Brent over WTI. However, in this latest push lower to the 5 years lows over the past 3 or 4 sessions we have seen that spread widen again with the current differential being 6.50 Brent over WTI once again. If, in fact, this sell off is all about China then one would expect the contract most directly affected by China (Brent) would be hit harder relative to WTI. The fact that this has not occurred most likely indicates that this 'fundamental' development out of China is being used to press the price discovery lower in exploratory fashion based on technical discovery.
The API data was relatively muted with a less than expected draw that should have little effect on the price with these more macro events occurring. EIA data would need to be more aggressively off estimates to produce any real movement.
Natural gas continues to grind higher with little in the way of fundamental developments except the natural seasonal bid that should be priced in to some extent. Tomorrow’s inventories should be key as well as seeing how the natural gas market reacts if there is a sharp corrective bid in the crude at some point.
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