~Weekly Overview~

De-escalation

Welcome to another blog update of the Weekly Overview Series.

In this week…

• Italy and Spain set lockdown de-escalation plans with fixed dates to return to normality. Meanwhile, the U.K will revise lockdown options and underscores a second-wave risk. In Germany, new Coronavirus’ cases increase the most in four days and obliges Merkel to decide on whether to extend lockdown or to continue the re-opening of the economy.

• Gilead has over 50,000 Remdesivir Courses ready to ship. The drug has met the overall target of the National Institute of Allergy and Infectious Diseases, asserting that it helps patients to recover faster. However, this data is still highly preliminary. The FDA has expressed its willingness to clear medical products for emergency use with less robust results than usual.

• US GDP shrinks at a 4.8% annualized pace in the first quarter, the biggest drop since 2008. The U.S economy is expected to contract at a 38% annualized according to Morgan Stanley in the second quarter. In Europe, France and Spain, with limited room for spending as they are saddled with huge debt burdens, were the most affected countries reporting contractions of -5.8% and -5.2% respectively in the first quarter.

• The Federal Reserve had on Wednesday its Federal Reserve Open Market Committee (FOMC) without reporting any specified forward-looking monetary policy measures. However, its Chairman, Jerome Powell, glimpsed that further action must be needed in the future to recover from this economic shock. The Federal Reserve balance sheet peaked at $6.6 trillion in assets, a historical maximum.

• Microsoft reported a revenue growth of 15% in the first quarter of 2020, exceeding expectations that were at 11%. Earnings per share jumped to $1.40 compared with $1.14 the year before. According to Satya Nadella, its CEO, two years’ worth of digital transformation occurred in just two months. He added the increase in remote working and learning along with rising demand for cloud infrastructure were behind the results.

A worth noting indicator: the VIX

The VIX (Volatility Index) provides a measure of implied market risk and sentiment looking at the S&P500 options expiring in 30 days.

Volatility is an integral input when valuing options. The price of an option will depend upon the market perceived probability of the underlying asset price moving above (below) the strike price if it is a call (put) option. An increase in volatility is directly proportional to an increase in the price of the option.

The VIX closed on Monday below its second-month future after two months of historical high spreads between them. This suggested a return to the typical structure of the two contracts. Since contracts dated further out carry a higher uncertainty than those closer in, they would tend to trade higher.

However, with Apple skipping forecast for the first time in many years and Amazon sparking concerns of a Q2 operating income loss due to its planned spending in Covid-related expenses, the VIX trades again at a higher price than its second-month implied volatility future.  

Oil recovers, temporarily?

After its historical negative prices in its May contract due to lack of storage capacity in the U.S, explained in the last blog entry, prices in the June contract seem to edge higher at the moment, trading at around $20.

This Monday, the United States Oil Fund, the biggest ETF in the oil market continued liquidating its June contract holdings in its strategy to increase the average expiration date of its holdings. Oil prices started the week dropping.

However, there has been three main reasons for this sudden change in the trend.

The first one, China.

China’s latest Purchasing Managers Index (PMI) data showed a stabilization in its domestic economy with the Non-Manufacturing PMI performing better than the Manufacturing. Traffic congestion levels have also picked up as factories reopen and people return to work. State-owned and independent refineries have kept processing rates at 13mb/d in April, matching the monthly average in 2019 and almost 4mb/d more than in February. The demand for oil ramps up in the Asian Giant.

The second reason is the natural reduction in U.S shale companies’ supply as prices are lower. They are obliged to cut production as at that low oil prices, they are unable to make a profit.

The third reason is the come into force of the OPEC+ supply cut agreement of 9.7mb/d today, with the additional cut promised by Norway.

What are the risks to the downside oil investors should consider?

Probably two.

In the short-term, the possibility of a big sell-off as the June contract expiration date comes closer due to a lack of storage capacity in main places as Cushing in Oklahoma. The API Weekly Crude Oil Stock increased by 9.978 millions of barrels, the 14^th consecutive week reporting an increase in inventories.

In the long-term, there is a risk of a second-wave Coronavirus cases in autumn that could harm even more the world economy. In this case, if uncontrolled, governments will have to face the new pandemic highly indebted and central banks will have little room for additional monetary policy with already huge balance sheets.

As usual, I leave here two useful charts:

Have a good weekend.