It could get very ugly this week, folks.
Traders and investors got a preview of what may be in store on Sunday, when Mideast shares plunged the most since the financial crisis on the heels of Saudi Arabia’s shock OSP cuts, which presaged the beginning of an all-out oil price war.
This is extremely problematic for a number of reasons, not least of which is that, with crude already down more than 30% in 2020 and the world on the brink of a potentially historic demand shock tied to coronavirus containment efforts, a supply deluge beginning next month risks a total collapse in the world’s most financialized commodity at a time when high yield spreads are already ballooning wider and US energy shares are trading at the lowest since 2008.
“The credit markets are going to find this very hard to deal with as liquidity has already dried up”, Raoul Pal said Sunday, before joking (sort of) that “Trump probably thanked Putin from the American consumer without realizing the damage caused”.
I do not know the exact numbers (e.g., where all the strikes are), but you’d be remiss not to at least consider the possibility that this could be amplified by the same gamma effects (tied to producer hedges) which famously accelerated Q4 2018’s crude collapse. One has to wonder about trend followers and momentum-chasing, programmatic players too.
“We believe the OPEC and Russia oil price war unequivocally started this weekend”, Goldman said Sunday. “The prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus”.
“Traders will struggle in premarket position jostling to comprehend the implications… but the [coming] three-way struggle for global oil dominance could pale in comparison to an unprecedented VaR implosion that will send global central banks and G-7 leaders back to the drawing board”, Axicorp’s Stephen Innes said, in an e-mailed Sunday note.
Crude plunged more than 30% out of the gate before trimming losses. It was the largest single-day drop since 1991. US equity futures dropped 5% amid chaotic, wild trading that also the Norwegian krone fall to the weakest since 1985. S&P futures were limit-down at 2819.
As Bloomberg helpfully (and rather dryly) points out, “the last time futures selling tripped the limit down rule was the night of November 8, 2016, as investors adjusted to news that Donald Trump would win the presidency”.
10-year US yields fell below 0.5%. 30-year yields fell below 1%. Let that sink in. The yen surged to the strongest since 2016.
Meanwhile, coronavirus deaths surged in Italy to 366, while the infection total rose to 7,375. Cases in France jumped above 1,000 and Saudi Arabia closed schools indefinitely. Tim Cook told some Apple workers they can work from home. COVID-19, Cook said, is an “unprecedented event”.
This chart comes with the usual caveat – namely that it will, almost by definition, be out of date by the time you see it, but it’s based on information available from government sources through Sunday evening in the US.
Axicorp’s Innes went on to muse that “we’re on the event horizon of a massive credit risk black hole as a financial disaster is brewing in the form of an industry wide meltdown”.
That may be a little hyperbolic – but maybe not. As I put it on Saturday evening, the Saudis’ decision to slash OSPs and hint at a possible ramp in production to 12 million b/d, is a “dramatic escalation”. There is nothing hyperbolic about that – it just is what it is.
Again, it’s impossible to overstate how poor the timing is on this potential oil price war and any attendant credit risk event(s). Credit was looking extremely nervous headed into the weekend, and in dollar-funding markets, pressure was manifesting in FRA/OIS (figure) and cross-currency bases.
To reiterate: Those are the kinds of “cracks” you don’t want to see. Wild action in equities is one thing. A sharp widening in credit spreads and signs of interbank stress are another matter entirely.
“There are signs of stress in almost every corner of financial markets”, SocGen’s Jason Daw said Sunday, in a note, adding that “nobody knows how the COVID-19 situation will evolve, but what is obvious is that it is a significant growth shock and the longer it sticks around, the risks of a full-blown crisis will grow”.
If credit buckles under the weight of collapsing oil prices and interbank stress keeps building against a backdrop of incessant headlines about the virus, markets will be left to teeter on the brink of a panic.
“Central banks may succeed in establishing a floor under risk assets, but it may require more than just conventional rate cuts”, Daw went on to say, before cautioning that “oil market developments over the weekend can compound already fragile market sentiment”.