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Forex Blog - FX Briefing - Oil price drop and stock market rally

FX Briefing 25 July 2008

Highlights

·        Weakening oil demand moves into focus, oil price drops

·        Subdued reaction of EUR-USD to oil price and stock market movements

·        Euro area business climate deteriorates, confidence wanes

Oil price drop and stock market rally
In the middle of this month, financial markets made a U-turn. In the first half of July rising oil
prices and fear of a systemic banking crisis in the
US pushed equities down. The low point came when measures to help ailing mortgage financiers Fannie Mae und Freddie Mac were announced by the US Treasury and the Fed, and Fed chairman Ben Bernanke spoke before Congress. Compared to the moderately optimistic comments in May and June, this time Mr Bernanke was more skeptical about the growth outlook. Moreover he did warn of inflationary risks but appeared confident that the price pressure would mediate in the medium term and did not drop any hints concerning possible interest rate hikes. In this phase, the dollar hit a new low against the euro at 1.6040; and USD-JPY fell to under 104.

All major markets turned in mid-July. Crude oil which had been quoted at over $145 per barrel
dropped to $136 within minutes on 15 July and then continued slipping to around $125. Equities, banks in particular, on the other hand have recovered in the past few days. The Dow for instance, gained 5% on its low on 15 July, the Dax rose by about 6%.

On the oil market, the most important factor is likely to have been that markets finally started pricing in the fact that the high prices are dampening economic growth and energy demand. The economic slowdown seems to be spreading increasingly in Europe too. Moreover warning
signs are increasing even in the emerging economies: Weaker demand from industrialized
countries and rising energy and food prices are a drag on growth, and there are increasing social tensions in some regions. Even
China has raised prices for petrol and diesel to rein in rocketing subsidies and to alleviate supply shortfalls and address misallocation.

Moreover, the IEA revised its demand forecast down, US inventory data were bearish, talks between the US and Iran were on the cards, and Hurricane Dolly spared oil and gas installations. Maybe the Democrats initiative in the US Senate to restrict speculative activity in the commodity markets played a role too. Moreover the SEC’s measures against short selling financials could have been a trigger: The combination of being long in oil and short in banks is supposed to have been a popular trade among hedge funds for instance.

The SEC’s measures and the Fed and the Treasury supporting Fannie Mae und Freddie Mac (and thus implicitly all other systemically relevant financial institutions) are likely to have been
the most important factors for equity markets rebounding. Otherwise the surroundings have not changed that much for equity markets. In the
US economic data releases were sparse and showed no discernible signs of a turn for the better. European data surprised on the negative side. Especially the July results for business climate and industrial confidence, including the German ifo index, showed a marked deterioration. The decline in oil prices does lighten up the picture a bit but the price level of oil (and other commodities) remains very high and is a burden on growth. All in all this looks like a “relief rally” to us.

The oil price drop and the equity market recovery also had an effect on the forex market. The dollar firmed against most of the European and Asian currencies. But the movement was limited, particularly against the euro. Currently, EUR-USD is quoted at 1.5750, which is less than 2% below the all-time high on 15 July. Moreover, the dollar’s moderate recovery did not start until a few days ago.

It looks as if the forex market participants are not convinced that the tide has really turned. Oil prices have not dropped far enough for long enough to change the overall scenario and thus
also change the direction of portfolio flows. In our opinion the dollar will not show a sustained rise until the
US economy has stabilized in comparison to the other economies. We think there is potential for this but only in the medium term when the European economy cools further, inflation rates start falling and the ECB loosens the reins.

Stephan Rieke +49 69 718-4114
Economics Department
+49 69 718-3642
volkswirtschaft@bhf-bank.com
Foreign Exchange Trading
devisenhandel@bhf-bank.com
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

 

<i>This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.

© 2007 BHF-BANK Aktiengesellschaft

All rights reserved. Please mention source when quoting from it.

 

 

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