For the time being, oil exposure is the new MBS exposure. People are scrambling to find out which bank sold oil-linked that turned out profitable and are trying to locate which outlets and what sizes bought notes that could leave them underwater. Most of the oil-linked notes were written in Q1 2014 and only expected a draw to between $80 and $85 per barrel, some lasting 1 year and others lasting to 2029. So far, holders of BNP Paribas notes are getting smoked.
In his regular weekly letter for Morgan Stanley, Joachim Fels added a new wrench into the spokes of the global economic wheel:
Via Morgan Stanley (emphasis mine):
It all starts with my favourite explanation for the low-growth, low-flation, and low-rates environment we've been living in for a while now: the global savings glut. For various reasons -- mainly demography, inequality, and technology -- desired saving in the world exceeds desired investment. Put differently, the global economy suffers from a deficiency of demand - both consumption and investment. The longer demand stays depressed, the more potential supply slows as temporary turns into permanent underemployment (hysteresis) and as weak investment dents the productive capital stock. As a consequence, the natural or equilibrium real rate of interest -- the rate that balances saving and investment at high levels of employment -- is probably deeply negative. If governments fail to fill the demand gap by raising public investment spending and thus the natural interest rate, central banks will be forced to push actual real rates into negative territory towards the natural rate in order to avoid depression and deflation. But with nominal rates already at zero and inflation approaching zero as well, this becomes ever more difficult. Hence the economy remains mired in malaise and central banks are blowing pretty bubbles in order to avoid worse outcomes. Yes, this is Larry Summers' 'secular stagnation' -- a very plausible narrative for our current economic situation.
Following the epic f**k up that we're calling the Great Recession global economies never recovered. We no longer have independent, revenue generating, value-creating markets. What we have is the equivalent of a 35 year old at home with Mom and Dad receiving assistance. We (in the USA) have a matured market that can't stand on its own anymore. The crippled systems needs the assistance of a fed walker (low rates) to keep it humming. This has progressively become more difficult thanks to central dimwits who decided they need a dashboard with as many knobs as possible so that they can use their PhD brilliance to plan and control equity, commodity, bond, FX, and labor markets.
Joachim points out that the drop in oil may actually do more to spur spending above and beyond pump savings (which are negligible, ignore that ignorant horseshit you hear on CNBC about low oil materially increasing disposable income or the stories about people jumping up from one standard of living to the next):
With supply exceeding demand and the world's swing producer Saudi Arabia refusing to cut production (see Quote of the Week below), oil prices plummeted another 10% this week to below $62pb for Brent, which is now down almost 40% from three months ago. For anybody worried about the savings glut and its implications, the oil glut should be good news as it redistributes purchasing power from oil producers, who with their low propensity to spend have added to the savings glut, to consumers who typically spend a higher proportion of their incomes.
If there is net benefit to the world, Joachim seems to believe that the offset from consumer spending will spur the dormant global investment activity. The kicker comes when he highlights what many of us who are ahead of the game expected, that the drop in costs in one of the major economic inputs may drive central planners to hike rates sooner than later, like in H1 2015:
If the oil glut indeed mitigates the global savings glut, real interest rates should rise. And hey, this is exactly what happened this week when 5-year TIPS yields rose 7 basis points. And if the oil glut mitigates the savings glut and boosts demand, central banks may be tempted to ease less or start normalizing interest rates earlier.
And if your wonder about the title of this post:
