Oil price rise continues, inflation fears spook Nasdaq

Equity markets tumbled this morning, led by Nasdaq’s 1.2% decline, with a sell-off in bonds and higher yields the culprit. Bonds were spooked by evidence that the US services sector unexpectedly gained steam in August, with new orders firming and businesses paying higher prices for inputs, both signs of still-elevated inflation pressures. The continued rally in oil prices, hovering around $88, added to inflationary fears, and we review whether this will go much further.

Bottom-line: risk-off.

TODAY’S MAJOR NEWS

Service sector inflation heating up

• Institute for Supply Management (ISM) data showed that the services, non-manufacturing, Purchasing Manager’s Index (PMI) rose to 54.5 last month, compared to an expected 52.5, up from 52.7 in July and the highest reading since February
• The survey reported that new orders received by services businesses rose to 57.5 last month from 55.0 in July
• The survey reported that prices paid by services businesses for inputs increased to 58.9 in August from 56.8 in July.
• Bottom line: A reading above 50 indicates growth in the services industry, accounting for more than two-thirds of economic activity.
• Data published last week showed that the Fed's preferred inflation measure, the personal consumption expenditures (PCE) price index, rose 3.3% in July, well above the 2% inflation target
• Fed policymakers view the services sector as key to bringing inflation down to their 2% target, and the ISM report does little to support the view that this is achievable

Saudi and Russian oil production cuts offset by increases from other OPEC members

The oil price trend over the past 60 days reflects concerns that global demand is out-pacing supply, drawing down supplies in the face of production cuts. StoneX energy analyst Harry Altham made the following comment on OPEC+, “extending, not expanding, production cuts”, providing some useful context. “While it is true that extending the production cuts will see demand outpace supply in the fourth quarter of 2023, the size of the deficit looks set to narrow as we approach October and November – particularly with strengthening non-OPEC production numbers.”

Yesterday’s OPEC+ announcement, in which Saudi Arabia and Russia extended voluntary output cuts until at least December, represented a combined 1.8 million barrel per day (bpd), including 1 million bpd for Saudi Arabia and Russia’s voluntary export cuts. This constitutes only a 1.7% reduction in global supply, removing a cumulative 295 million bpd from global supply between July 2023 and January 2024.

About 30% of this oil production shortfall is expected to flow into China as Iranian imports. Last month’s OPEC production figures showed overall production rising by 200,000 bpd to 27.6 million bpd, with surging output from Iran. The Iranian oil Minister is quoted as saying productive capacity has risen by 40% in the past two years and that production will rise to 3.4 million bpd ‘by the end of summer’.

So, while headlines focus on the Saudi and Russian production cuts, global oil supply is actually pretty robust and might soon outrun output reductions.

Fed’s Beige Book reports moderating economic activity and inflation in July and August

The Federal Reserve’s Beige Book is published eight times a year two weeks ahead of the next meeting of the Federal Open Market Committee. The Beige Book provides a detailed analysis of the US economy that policymakers study when considering potential changes to monetary policy. This Beige Book is expected showed a resilient economy, albeit with signs of slowing.

• Consumer spending, specifically tourism, was stronger than expected – but non-essential retail spending is slowing as consumers exhaust their savings and rely on borrowing to support spending
• New auto sales increased as inventory improved
• Manufacturing business reported that supply chain delays improved, but new orders were stable or declined
• Single-family housing supply is not improving, with inventory limited and modest new home construction
• Bankers reported that consumer loan balances rose, but some Districts reported higher delinquencies on consumer credit
• Job growth was subdued
• Nonetheless, growth in labor cost pressures was elevated in most Districts, as skilled workers were in short supply
• Most Districts reported price growth slowing, decelerating faster in manufacturing and consumer-goods sectors than services
• Several Districts indicated input price growth slowed less than selling prices, as businesses struggled to pass along cost pressures
• As a result, profit margins reportedly fell in several Districts

Chinese property developer to restructure debts

• Cash-strapped property developer Country Garden said would soon undergo debt restructuring to address its sizable offshore bond load, as it announced the extended payment of eight onshore bonds
• Chinese markets continue to believe that loser monetary policy and lower interest rates will be required to prevent the real estate crisis from becoming an economic crisis
• The offshore Chinese yuan hit a low of 7.3248 in early trading hours, close to the 15-year lowest of 7.3280 last November
• Chinese stock markets were mixed today, with the Shanghai Composite Index edging up 0.24%

TODAY’S MAJOR MARKETS

Equity market’s mixed, Nasdaq relative loser

• Equity markets were weak in morning trade, led by a 1.2% fall in Nasdaq, 0.8% in the S&P 500 and 0.6% in the Russell 2000
• Global markets were mixed overnight, with the FTSE and DAX down by 0.2% while the Nikkei 225 was up 0.6%
• The VIX, Wall Street’s fear index, rose to 14.5

Short bond yields over 5% on inflation fears

• 2-year and 10-year bonds rose to 5.03% and 4.30% respectively
• The dollar index rose 0.1% to 104.9
• Versus the dollar, the Yen and Euro were unchanged, while Sterling was 0.4% lower

Oil rally continues

• Crude oil prices rallied 0.5%, to $87.1 per barrel
• Spot gold and silver prices were unchanged at $1,947 per ounce and $22.4 per ounce, respectively
• Grain and oilseed markets held on to notable gains, supported by larger-than-expected drops in crop ratings on Tuesday afternoon, technical chart signals and short-covering by fund managers holding large short positions

Analysis by Arlan Suderman, Chief Commodities Economist: [email protected] 

Market outlook by Paul Walton, Financial Writer: [email protected]