EC Oil Continues To Slide, Blowing Deflationary Winds

Brent oil is off another 3% today, Tuesday January 13th, taking its decline since the end of last year to 20%. This is overshadowing other macro-economic forces. With the Federal Reserve among the least likely central banks to respond, the dollar is firm, even if within recent ranges.   

The deflationary forces are depressing bond yields, arguably more than central bank buying could, and encouraging investors to move into equities.  Core European bonds yields, as well as Spanish and Italian benchmark 10-year yields are off 3 bp. US 10-year Treasury yields are also off 3 bp and are just above the mid-Oct flash crash low of 1.86%.  A break here could spur another 20-30 bp move from a technical perspective.  

Asian equities struggled after US equity losses yesterday and with Japan re-opening after yesterday’s holiday. Chinese equities snapped their small losing streak.  On the other hand, European shares are moving higher with the Dow Jones Stoxx 600 up 0.75%, though the energy sector is a drag. The decline in energy prices is expected to boost disposable income, and this is helping the consumer staples and discretionary sectors. 

The US corporate earnings season formally began with Alcoa yesterday.  Both its top and bottom lines beat expectations. Foreign exchange developments actually worked to its benefit, contrary to media reports that made it seem as if they would only work against US earnings. Yesterday the S&P 500 closed the downside gap created from the higher opening on January 8, easing some of the technical downside pressure. US shares are trading higher in Europe, pointing to a higher open today.  

Two inflation reports and two trade reports dominate today’s macro-economic developments. The UK reported a 0.5% year-over-year increase in CPI. This was below the 0.7% consensus and is half the pace seen in November. BOE Governor Carney has to write a letter to Chancellor of the Exchequer Osborne to explain the undershoot. Energy and food prices are the key drivers. We note that the core rate actually ticked up from 1.2% to 1.3%. The December short-sterling futures firmed to test the contract high set last April at 99.32 (implied yield 68 bp) as the market all but give up on the idea of a rate hike this year.