The GERM Report

Risk level: Yellow

RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)

THE BOOSTER SHOT

• The market, for better or worse, seems rudderless.
• Reciprocity is out of fashion.

The Japanese economy may be following Germany and tilting toward recession, according to government data released during the weekend. Recent contraction in the world’s third-largest economy was blamed in part on the coronavirus, though fourth quarter data indicate weakness was there before the global health alarms were sounding. So far, the market reaction in the midst of the virus outbreak has been asymmetric, with short-term rallies masking underlying weakness. The volatility may be indicative of a market that, like the international community in the current era, is rudderless.

Crude oil prices were stimulated last week by assessments that global fears from the coronavirus may have already peaked. Despite steady signs of a demand problem, Brent finished the week up 5.2% to close Friday at $57.32 per barrel.

Japan’s economy shrank by an annualized rate of 6.3% during the fourth quarter, the sharpest contraction since second quarter 2014. It would be easy to assign blame on the Asian spillover from the coronavirus, with oil building up in storage in the regional economy. That build is indicative of economic contraction, as travel slowdowns start to drag on key segments like manufacturing. Last week, the IEA in its latest monthly report downgraded its growth forecasts, citing demand destruction from coronavirus. On Monday, the People’s Bank of China injected some $14.3 billion into the financial system, seeking to calm market nerves.

A joint technical committee to parties to the OPEC+ curtailment program recommended trimming some 600,000 bpd from the market to address the decline in demand. Russia, which needs oil priced at somewhere around $50 per barrel, has balked at the proposal. That leaves Saudi Arabia, which needs a higher price point in order to cash in on the Saudi Aramco IPO, relatively defenseless in the current market climate. Meanwhile, the market is still working to adjust to the change in flows from the IMO’s new sulfur limit on marine fuels, which is changing everything from favored suppliers to refinery slates. Data firm Enverus adds the IMO 2020 changes everything, “from steel to sugar,” as shipping costs increase in response to the fuel premium added by the sulfur cap. Those headwinds also predate the coronavirus outbreak and, coupled with the pressure from mercantilist trade policies, can help at least partially explain why the World Trade Organization is saying that “while the year-on-year growth figures for the fourth quarter may pick up slightly, the latest [trade] barometer reading provides no indication of sustained recovery.”

Mercantilist trade policies, such as those favored by the Trump administration, lean on me-first strategies that do little for reciprocal benefits. That bodes well for an administration that sees multilateral trade as a weakness and prone to exploitation. In the oil market, US Energy Secretary Dan Brouillette said the US is a net exporter “of energy” and thereby free from “dependency on malign nations who do not hold our best interests at heart.” Breaking the bonds of dependency aligns with a self-help strategy that draws from the pages of Adam Smith, where it is anything but consideration for another’s well-being that drives success. Logic would dictate that success breeds mimicry, whereby others looking for a win emulate the behavior of the winners. That, in turn, lines up with Washington’s penchant for realism, the doctrine that says self-interest is the only true interest in a system without a common power to keep the world in awe, to borrow from Hobbes. This may explain Russia’s role in OPEC as well, as the Kremlin sees price manipulation as a way to infuse its self-interest into the global market. A market that’s just right for Russia hobbles the United States. Hobbes also warned of a “perpetual and restless desire” for power, showing that mercantilist trade policies line up with the trend toward oligarchy. But when power is consolidated in the hands of a few-self interested souls, there is little interest to lead a liberal system that by design tempers the perpetual desire for power. Without a governor, any system, be it the international system or the international economy, is rudderless and exposed to the vulnerability of extremes.

Monday is a federal holiday in the United States, so markets will be relatively quiet. Tuesday brings a reading of consumer sentiment in the eurozone and a poor reading may be expected given the latest trends in GDP. We get a look Wednesday at US Fed thinking when minutes from the January meeting are released. Also watch for signs of a continued US glut in API and EIA figures. A deeper dive into the Japanese economy comes Thursday with the national price index for January. The week ends with the release of the US PMI for February. Brent seems to be stuck in something of a tunnel, with room to bounce between $60 and $56 per barrel. More fluidity can be expected this week, but the choppier waters may be in the rear-view mirror. A Yellow alert is in place for the week, with Brent looking to swing by +/- 2%.