Janet Yellen Testifies: Five Key Things To Look For

This morning, Janet Yellen testifies before the House Financial Services Committee on financial regulation topics. While there us unlikely to be much talk of monetary policy, it may come up, although most of the lawmakers’ questions are likely to relate to the Fed’s oversight of banks; other questions may touch on the Fed’s recent bank commodity oversight push, the November election, and especially the recent Wells scandal.

Here are the main things to watch for, courtesy of the WSJ:

  • Big Bank Stress Tests

The Fed announced major changes to its stress testing regime on Monday, detailed in a new rule proposal and a 29-page speech from Fed governor Daniel Tarullo. Expect Ms. Yellen to get quizzed about the changes, which generally make the tests easier to pass for regional banks and tougher on global megabanks. Several lawmakers, especially Republicans, have their own ideas about how the Fed should make further changes to the tests, including by revamping the way it measures banks’ riskiness.

  • Banks in the Commodities Business

Last week, the Fed took another regulatory action that is sure to generate attention from members of Congress: It proposed new rules targeting some of banks’ commodity-market businesses, citing the risk of outsize liabilities in the event of an environmental disaster. Lawmakers might take the view that the rules are an end-run around Congress, which explicitly allowed banks to engage in those activities in 1999. Big banks have also lobbied extensively against the rules, with help from local officials who say they rely on banks to help finance purchases of natural gas and other commodities for their municipalities.

  • Wells Fargo and Executive Compensation

Republicans are likely to ask Ms. Yellen why the Fed and other regulators didn’t do more to stem misconduct at Wells Fargo, while Democrats will push for her to commit to finishing the incentive pay rules soon—a promise Comptroller of the Currency Thomas Curry made last week.

  • Monetary Policy

Fed policy makers’ decision last week to hold interest rates steady while hinting at an increase in the near future could easily come up Wednesday. The Fed chief made clear she was ready for a bump up in borrowing costs, saying the case for a rate increase “has strengthened.” Democrats could press Ms. Yellen on the effect that higher interest rates would have on the labor market, particularly among low-income and minority workers, who have been slow to recover from the recession. Republicans on the other hand could push for higher rates.

  • The Election

The Fed is finding itself in an unusual position this election cycle. While central bank officials try very hard to maintain their impartiality and skirt all talk of politics, they have had to parry charges from Donald Trump, the Republican presidential nominee, that they are artificially holding rates down to make President Barack Obama look good and to help Democrat Hillary Clinton get elected. Ms. Yellen spent much of her news conference last week defending the Fed’s impartiality. Mr. Trump accused the Fed again during Monday night’s debate of “doing political things.” Ms. Yellen could face questions related to the election from both sides of the aisle Wednesday. Don’t look for her to say more than she did during last week’s news conference, however.

* * *

Watch the hearing live below:

Janet Yellen’s Prepared Remarks…

Yellen Testimony

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Are “Invisible Americans” The Key Players In This Election?

Submitted by Charles Hugh-Smith via OfTwoMinds blog,

Memo to the D.C. Beltway/mainstream media apologists and propagandists: the 25 million Invisible Americans are no longer buying your shuck-and-jive con job.

For the bottom 90% of American households, the "prosperity" of the "recovery" since 2009 is a bright shining lie. The phrase is from a history of the Vietnam War, A Bright Shining Lie: John Paul Vann and America in Vietnam.

Just as the Vietnam War was built on lies, propaganda, PR and rigged statistics (the infamous body counts–civilians killed as "collateral damage" counted as "enemy combatants"), so too is the "recovery" nothing but a pathetic tissue of PR, propaganda and lies. I have demolished the bogus 5.3% "increase" in median household income, the equally bogus "official inflation" body counts, oops I mean statistics, and the bogus unemployment rate:

Fun with Fake Statistics: The 5% "Increase" in Median Household Income Is Pure Illusion (September 19, 2016)

What's the Real Unemployment Rate? That's the Wrong Question (September 14, 2016)

Could Inflation Break the Back of the Status Quo? (August 5, 2016)

Revealing the Real Rate of Inflation Would Crash the System (August 3, 2016)

Inflation Hidden in Plain Sight (August 2, 2016)

The Burrito Index: Consumer Prices Have Soared 160% Since 2001 (August 1, 2016)

I'm not the only one calling the "recovery" a lie: the chairman of Gallup, Jim Clifton, recently unloaded on the "recovery":

The Invisible American.

"I've been reading a lot about a "recovering" economy. It was even trumpeted on Page 1 of The New York Times and Financial Times last week. I don't think it's true.

The percentage of Americans who say they are in the middle or upper-middle class has fallen 10 percentage points, from a 61% average between 2000 and 2008 to 51% today."

Now that is a self-reported number. The reality is much worse: only 20% of American households possess the income and assets that characterize the middle class in financial terms. Granted, someone making $28,000 a year can self-identify as middle class, but if we look at basic metrics of financial security, they're not even close.

I have analyzed this in depth for years:

The Three-and-a-Half Class Society (October 22, 2012)

What Does It Take To Be Middle Class? (December 5, 2013)

The Destabilizing Truth: Only the Wealthy Can Afford a Middle Class Lifestyle (May 6, 2014)

America's Nine Classes: The New Class Hierarchy (April 29, 2014)

We got your "middle class" right here: see that little green slice of the pie? The upper middle class is the purple slice, and the top 10% is blue (most of this wealth is held by the top 1% and top 5%.)

Jim Clifton calls those who have been pushed out of the middle class Invisible Americans: here is his report:

"Ten percent of 250 million adults in the U.S. is 25 million people whose economic lives have crashed.

What the media is missing is that these 25 million people are invisible in the widely reported 4.9% official U.S. unemployment rate.

Let's say someone has a good middle-class job that pays $65,000 a year. That job goes away in a changing, disrupted world, and his new full-time job pays $14 per hour — or about $28,000 per year. That devastated American remains counted as "full-time employed" because he still has full-time work — although with drastically reduced pay and benefits. He has fallen out of the middle class and is invisible in current reporting.

More disastrous is the emotional toll on the person — the sudden loss of household income can cause a crash of self-esteem and dignity, leading to an environment of desperation that we haven't seen since the Great Depression.

Millions of Americans, even if they themselves are gainfully employed in good jobs, are just one degree away from someone who is experiencing either unemployment, underemployment or falling wages. We know them all."

This is where the bright shining lies come in. The worker now earning $28,000 annually is counted as employed, but there is no official metric for the household's increasing insecurity and loss of opportunity.

Even worse, nobody tracks the erosion of benefits. Not only has nominal pay plummeted from $65,000 to $28,000, the deductions for the employee's share of healthcare insurance have skyrocketed, along with co-pays for meds, visits to a doctor, eyewear, etc.

The lucky employees may still receive the benefit of matching 401K retirement funds from the employer, but the matching sums have declined.

This is death by a thousand cuts. According to a report by the St. Louis Federal Reserve, real (adjusted for official inflation) wages have risen a mere 3% since 1970–46 years ago.

Could the 25 million Invisible Americans be the key swing demographic in the upcoming presidential election? As I noted in What If We're in a Depression But Don't Know It? (September 23, 2016), The top 5% of households that dominate government, Corporate America, finance, the Deep State and the media have been doing extraordinarily well during the past eight years of "recovery," and so they report that the economy is doing splendidly because they've done splendidly.

The gulf between reality and the official happy story of "recovery" spewed by the status quo's well-paid army of apparatchiks, flunkies, flacks, hacks, toadies, lackeys and functionaries gorging at the trough of the status quo is widening to the point of surrealism. Memo to the D.C. Beltway/mainstream media apologists and propagandists: the 25 million Invisible Americans are no longer buying your shuck-and-jive con job.

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First ‘Three Parent’ Baby Born in Mexico

ThreeparentbabyGreat news! American fertility specialists replaced defective mitochondria in a embryo resulting in the birth of a healthy baby boy five months ago. The bad news is that due to a fifteen year Food and Drug Administration ban, the procedure had to be performed in Mexico.

Mitochondria are the energy producing organelles in each of our cells which carry their own small genomes and are passed down to children from their mothers. Broken mitochondrial genes cause a wide variety of illnesses from which about 1 in 4,000 people suffer (that is about the same rate as cystic fibrosis among European-descended Americans). In this specific case, the mother carries a mitochondrial mutation associated with Leigh’s Disease that causes brain lesions and which killed her first two children. The cure was achieved, as the New Scientist explains:

[New Hope Fertility Center specialist John] Zhang … removed the nucleus from one of the mother’s eggs and inserted it into a donor egg that had had its own nucleus removed. The resulting egg – with nuclear DNA from the mother and mitochondrial DNA from a donor – was then fertilised with the father’s sperm.

Zhang’s team used this approach to create five embryos, only one of which developed normally. This embryo was implanted in the mother and the child was born nine months later.

Hearty congratulations are in order to the parents, the baby, and the team that made it possible! Well, not everyone actually agrees with that sentiment. CNN reports:

“It’s unfortunate to have people decide they’re just going to quite willingly engage in this kind of reproductive tourism — to go outside of a system that is in place to create the safest, most scientifically reproducible way forward,” said Lori P. Knowles, assistant professor, adjunct, at the University of Alberta School of Public Health. “That’s the precedent then, that if you think you can do it, then let’s just hop the border and see what happens, hope for the best.”

Cannot bioethicists hear themselves! Having endured four miscarriages and two dead children, this mother had already seen “what happens,” so of course, she was hoping for best. So should we all.

The parents in this case obviously felt forced to engage in reproductive tourism because the “system that is in place to create the safest … way forward” has, in fact, blocked all progress in this field for a decade and a half. While headlines around the world hailed this achievement as the first three-parent baby, that’s actually not the case. Back in 2000, researchers at St. Barnabas Hospital in New Jersey developed the same technique that Zhang used. As I reported earlier:

Researchers hit on the idea of curing mitochondrial diseases by replacing defective mitochondria with healthy ones derived from eggs donated by other women. Back in 2001, fertility specialist Jacques Cohen and his colleagues at St. Barnabas Hospital in New Jersey transferred ooplasm containing mitochondria from healthy donor eggs to the eggs of women experiencing infertility. The experiments resulted in the births of 15 healthy babies. …

When the Food and Drug Administration (FDA) got wind of the new development, the agency asserted that it had jurisdiction over the treatments and promptly banned them. And that is where matters have ever since stood, as women continued to endure infertility and more babies were born suffering from mitochondrial diseases. Very ethical.

The “safest system” is evidently the system that says take no risks at all. Better more babies born naturally with dread diseases than allowing parents to try to have healthy children by availing themselves of the unnatural methods of science. If regulators and bioethicists don’t want “reproductive tourism,” then stop banning research here. Instead of better safe than sorry, we will instead end up more sorry than safe.

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California Police Shoot Unarmed Black Man Behaving “Erratically” In Southern California

Crowds gathered after an unarmed black man who was “behaving erratically” died after being shot by a police officer in El Cajon in southern California on Tuesday, the local police department said, appealing for calm.

The death comes less than two weeks after black men in Charlotte, North Carolina and in Tulsa, Oklahoma, were shot dead by police, sparking protests. In Charlotte, rioting prompted the authorities to impose a state of emergency.

As Reuters reports, EL Cajon Police Department spokesman Rob Ransweiler told reporters that two officers responded to a call about an “erratic subject” who was claimed to be walking into traffic. The man refused their instructions to remove his hand from his pocket and then pulled out an object from his pants and pointed it at them, the department said in a statement. The officers then simultaneously shot and Tasered the man who died after being taken to hospital, the department said.

A woman on the scene who claimed to be his sister is saying that she was the one who called the police, because her brother needed medical attention, NBC-owned local channel KNSD reported. A witness who lives nearby told KNSD that he saw police officers surround a black man with their guns drawn. He described the man as seeming fearful and lurching to the side with his hands up before being shot five times by the police. A second witness claimed to have seen the same thing.

However, an employee at the restaurant of the parking lot where the confrontation took place claimed to have recorded the entire incident. Her manager told KNSD that she had seen the video and heard police instruct the victim to remove his hands from his hip. It is not known whether his hands were in his pockets, pants or just on his hip. The video allegedly also showed the victim’s sister pleading for her brother to cooperate. Police have viewed the video and interviewed the employee.

An additional witness was recorded in a Facebook Live video saying that the sister was pleading with her brother to take his hands out of his pockets and when he did, “he did have something in his hand but it wasn’t a gun.”

Statements made by the sister to reporters also imply that her brother was not showing his hands. His sister was recorded crying “He’s so sick” in a Facebook Live video posted by another woman on the scene.

During a news conference hours after the shooting, El Cajon Police Department Jeff Davis said no weapon was found on the scene. He did not say what exactly the man pointed at the unidentified officers.

The man, who was later identified as Alfred Olango, was hospitalized and left in a critical condition, according to Fox-affiliate KSWB. However his sister told reporters that her brother died at the scene. The American Civil Liberties Union later confirmed the man died, but did not specify where and when.

Other videos show her asking police, “Why couldn’t you guys tase him? Why, why, why? I told you he’s sick.”

“I called you to help me but you killed my brother,” she also said.

It remains unknown whether the man was armed. When Ransweiler was questioned about it, he told KNSD, “I have the information, I’m just not…It’s an ongoing investigation, so I’m not releasing details of the investigation.”

The shooting is not the only El Cajon police action under scrutiny. Employees at the nearby Los Panchos restaurant claimed that police confiscated cell phones from employees and advised them to not talk to anyone about the shooting.

The ACLU has released a statement saying, “there are disturbing reports from a number of witnesses that police officers confiscated cell phones from people who witnessed the shooting. Confiscating cell phones is a violation of the Fourth Amendment (unreasonable seizure without warrant or exigent circumstance) and the First Amendment (interference with the right to record in public) under the U.S. Constitution and analogous rights under the California Constitution.”

El Cajon Police have denied confiscating cellphones and urged the community to “please be careful about reacting to inaccurate information.”

Many people claim that the man was having or had recently had a seizure when he was shot. While there has been no official statement on his health or condition at the time of the shooting, confusion and unresponsiveness can occur after a grand mal seizure.

“Now is a time for calm,” Davis said at the news conference. “I implore the community to be patient with us, work with us, look at the facts at hand before making any judgment.”

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End Of An Era: BlackBerry To Stop Making Smartphones

The age of the iconic keyboard-ed smartphone is over as BlackBerry’s John Chen confirmed that the firm will stop developing hardware in-house as its pivot to software shows “signs of momentum”.

As Bloomberg reports,

BlackBerry has completely outsourced smartphone design and production, a process that Chen had been doing piecemeal since taking over as CEO almost three years ago.

 

 

Analysts had been holding their breath for the news after Chen said September was his deadline for making the chronically money-losing device business profitable. BlackBerry’s device business, which it calls “Mobility Solutions,” will focus on developing applications and an extra-secure version of Google’s Android operating system that it can license to other companies.

 

“Our new Mobility Solutions strategy is showing signs of momentum, including our first major device software licensing agreement with a telecom joint venture in Indonesia,” Chen said in a statement.

 

“Under this strategy, we are focusing on software development, including security and applications. The company plans to end all internal hardware development and will outsource that function to partners. This allows us to reduce capital requirements and enhance return on invested capital.”

What will Hillary do?

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House Reaches Deal On $170MM Aid To Flint To Avoid Government Shutdown

Nancy Pelosi and Paul Ryan have seemingly reached a deal to keep the federal government running for another 3 months.  A deal was originally delayed over a dispute on funding for the water crisis in Flint, Michigan, Zika funding for Florida and aid to flood victims in Louisiana.  The agreement struck between Ryan and Pelosi ultimately will provide $170 million to help Flint and other cities with water emergencies which would be added as an amendment to a separate water projects bill.

According to The Hill, the agreement comes after Senate Democrats and a handful of Republicans blocked a stop-gap spending bill to fund the government past Sept. 30.  Democrats vowed to block the stopgap funding bill Tuesday afternoon, after a House version of the bill included aid to Florida to fight the Zika virus and aid to help Louisiana flood victims but did not provide funding for the water crisis in Flint, Michigan.  

Per NBC, Senate Minority Leader Harry Reid (D-Nev) vowed to fight any legislation that excluded funding for Flint.

Democrats have been clear that Congress should not leave Flint and other lead-tainted communities out of any (stopgap spending) negotiation that includes emergency disaster funding.  Our request is simple: include both bipartisan disaster relief packages for consideration in the CR. We urge you to include bipartisan Flint legislation in the CR.”

Paul Ryan

The Senate originally passed a version of the waterways bill that included a $220 million Flint aid package, but the House version lacked the same drinking water provisions. That said, the House Rules Committee agreed late Tuesday night to allow a floor vote on a bipartisan amendment from Reps. Dan Kildee (D-Mich.) and John Moolenar (R-Mich.) that would authorize up to $170 million for communities around the country that are facing a drinking water crisis. 

The deal between the House leaders promises to free up the short-term spending measure, which had failed to advance in the Senate on Tuesday. That had left lawmakers facing responsibility for a government shutdown at midnight Friday, if they did not act.

Of course, with the presidential election just a couple of months away it’s not terribly surprising that this issue was cleared up with relative ease.

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Dad of ‘Clock Kid’ Sues Glenn Beck, El Cajon Cops Won’t Release Video of Fatal Shooting, Flint Funding Deal Reached: A.M. Links

  • An unarmed, unidentified man “acting ‘erratically’ near a strip mall” Tuesday in El Cajon, California, was fatally shot by local cops after “raising his arms in in a manner that looked as if he was holding a gun,” the Los Angeles Times reports. One officer fired a Taser but the other unloaded his shotgun at the same time. The cops were not wearing body cameras, and a witness voluntarily turned over cellphone footage of the shooting which police now refuse to release.
  • Reps. Paul Ryan and Nancy Pelosi reached a deal regarding federal aid to Flint, Michigan, which should help us avoid the dreaded (and yet somehow always narrowly thwarted) Government Shutdown.
  • RIP culture wars?
  • Maryland and Washignton police have been using a service that monitors, maps, and stores residents’ social-media posts.
  • The father of “Clock Kid” Ahmed Mohamed has filed a defamation lawsuit against conservative commentator Glenn Beck and Irving, Texas, Mayor Beth Van Duyne.
  • Activist Laura Lee has won the right to challenge a North Irish law that criminalizes prostitution clients.
  • Police misuse of criminal-justice databases to scope out spouses, crushes, journalists, neighbors, etc. is likely widespread in the U.S., according to a new AP investigation. Just looking at law-enforcement officers and staff disciplined for such transgressions, AP found 575 cases departments between 2013 and 2015, with 325 of these serious enough to warrant a firing, resignation, or suspension. “The misuse represents only a tiny fraction of the millions of daily database queries run legitimately,” AP volunteers, although the tally, “based on records requested from 50 states and about three dozen of the nation’s largest police departments, is unquestionably an undercount. Some departments produced no records at all. Some states refused to disclose the information.”

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Core Durable Goods Orders Contract For 20th Straight Month – Longest Non-Recessionary Streak In US History

In the last 60 years, the US economy has never suffered such a long contraction in core durable goods orders (20 months) without officially being in recession.

It's probably nothing… US Durable Goods New Orders Ex Transports YoY down for the 20th straight month…

 

Headline (short-term) data beat thanks to notably lower revisions.

  • Durable Goods Orders unchanged MoM (exp -1.5%, prior revised markedly lower from +4.4% to +3.6%)
  • Durables Ex Trans -0.4% MoM (exp -0.5%, prior revised lower from +1.3% to +1.1%)
  • Capital Goods New Orders Non-Defense, Ex-Aircraft +0.6% (-0.1% exp but prior revised from +1.5% to +0.8%)

But for the 4th month in a row, Capital Goods Shipments (Ex Air) fell MoM – down 0.4%, missing expectations of a 0.1% rise, and historical data was revised lower.

Thank the lord of war forsaving the economy again…

  • 5.8% drop in Computer new orders
  • 0.5% drop in Machinery
  • 0.5% drop in Fabricated products
  • 2.0% drop in Communication equipment
  • 2.5% drop in Electrical equipment and appliances
  • 21.9 drop in Nondefense aircraft and parts

BUT

  • 23.6% surge in defense capital goods new orders

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“There’s A Real Problem Here” – Did Fed’s Plosser Just Admit Trump Is Right About Yellen?

Former Philly Fed President Charles Plosser got a lot off his chest this morning during a Bloomberg TV interview. Decrying that central bankers “wring their hands all the time,” Plosser noted that The Fed was very “concerned about credibility,” and was “pretty good at conjuring up reasons not to act.” His mutinous discussion then concluded, soundingvery Trumpian, by noting that The Fed “shouldn’t be afraid a recession might come,” exclaiming “there’s a real problem here” with The Fed.

Additional headlines include:

  • *PLOSSER: FED’S `IN A VERY DIFFICULT POSITION’
  • *PLOSSER: `THERE’S A REAL PROBLEM HERE’ WITH FED
  • *PLOSSER: FED IS VERY CONCERNED ABOUT CREDIBILITY
  • *PLOSSER: CENTRAL BANKERS `WRING THEIR HANDS ALL THE TIME’
  • *PLOSSER: THERE’S FED DISSENT BECAUSE THERE IS UNCERTAINTY
  • *PLOSSER: `DISSENT IS HELPFUL’ FOR FED
  • *PLOSSER SAYS FED PRETTY GOOD AT CONJURING UP REASONS NOT TO ACT
  • *PLOSSER SAYS FED SHOULDN’T BE AFRAID RECESSION MIGHT COME
  • *PLOSSER: WISHES FED ‘WOULD GET ON WITH IT’ AND RAISE RATES
  • *PLOSSER: NOVEMBER FED MEETING ‘NOT A DEAD MEETING BY ANY MEANS’

It seems Yellen is losing control of the narrative as more and more insiders ‘get outside’; and perhaps, after all the establishment shock, Trump is right about the political nature of The Fed.

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Not Even An OPEC Deal Will Stop Oil Going Lower, Goldman Warns

Having been bullish for nearly half a year, yesterday Goldman’s flipped again, when it cut its Q4 oil price target from $50 to $43, admitting the previously anticipated rebalancing will take longer to achieve, and now expects “a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously.” Moments ago, the same Goldman analyst released a follow up note, confirming what we have been saying for the past year, namely that OPEC is increasingly irrelevant as a marginal supply-setter in a world in which it is the lack of demand that is a far bigger threat.

In “OPEC won’t stop oil going”, Damien Courvalin writes that “an OPEC deal to curb oil production, either today or at the November meeting, is thought more likely than at any point in the past two years.” That said, he notes, “we remain sceptical of its impact. For one, our production forecast continues to reflect a seasonal Saudi production decline into year-end, with no growth elsewhere. Second, even with this OPEC help, our updated oil supply-demand forecast now points to a renewed build in inventories in 4Q 2016 vs. a forecast for a draw only last month. This weaker oil outlook into year-end led us yesterday to lower our year-end WTI oil price forecast to $43/bbl, from $51/bbl previously. Given a well-supplied market and a crude curve in contango (with limited spot upside).”

Here are the details behind Goldman’s pessimism:

Intraday oil price volatility has picked up over the past week and ahead of today’s OPEC advisory meeting in Algiers. Statements by participants suggest a deal to curb production today or at the next meeting in November is more likely than at any point over the past two years. We remain sceptical of its impact, for two reasons: (1) independent of today’s outcome, our production forecast continues to reflect a seasonal Saudi production decline into year-end and no growth elsewhere, the equivalent of a deal; and (2) even with this OPEC help, our updated oil supply-demand forecast now points to a renewed build in inventories in 4Q 2016 vs. a forecast for a draw only last month.

This weaker oil outlook into year-end led us yesterday to lower our year-end WTI oil price forecast to $43/bbl, from $51/bbl previously, and still below the forward curve even after yesterday’s sell-off (“Beyond Algiers, weakening oil fundamentals,” September 27, 2016). While a potential OPEC deal today could support prices in the short term, we find that the potential for fewer disruptions and the relatively high speculative net long positioning instead leave risks to our forecast squarely skewed to the downside. Given the uncertainty on forward supply-demand balances, we reiterate our view that oil prices need to reflect near-term fundamentals – which are weaker – with a lower emphasis on the more uncertain longer-term fundamentals.

This renewed weakness in fundamentals reflects the three key drivers of the ongoing oil market rebalancing:

  • New Oil Order: Low cost production continues to surprise to the upside, most recently in Saudi Arabia and the UAE, previously in Iraq and Iran, and next in Russia. This relentless production growth reflects the core of the New Oil Order, where the flattening of the oil cost curve created by shale leads to a loss of pricing power by low-cost producers, leaving them with only volume growth to sustain fiscal revenues (“OPEC loses pricing power, shale shifts to the margin,” October 26, 2014).
  • Wall of Supply: The ramp up in new production capacity outside of OPEC is set to accelerate into year-end, with 2017 additions of projects started up to 2014 expected to be 30% higher than in 2016 (“The Battle for Capital: A Flatter Cost Curve Drives OPEC Growth and Non-OPEC Deflation,” Top Projects 2016, May 20, 2016). In turn, the US production declines are set to slow even at the current low rig count given the rising age of producing wells (less drilling of new wells) and the much smaller decline rates of mature shale oil wells.
  • Détente: Collapsed fiscal revenues are incentivising both a ‘detente’ in areas where geopolitical conflicts have disrupted production as well as a deflationary reduction in local taxation as countries fight to compete with US shale for revenues and capital (“More worried about a thaw than a freeze,” Commodities Research, August 22, 2016). As a result, the surge in short-term production disruptions that balanced the oil market unexpectedly in 2Q 2016 is slowly starting to reverse.

Importantly, even if disruptions remain at current levels in Libya and Nigeria, and Saudi reduces production into year-end, we project that global oil supply will continue to rise in coming months driven by low cost production growth and new project deliveries. We continue to view such supply shifts as the key drivers to oil prices through 2017, especially given today’s high level of inventories. Oil demand growth, and in particular China’s, has remained the bright spot of the oil market over the past two years. This strong demand growth has been supported by both low prices as well as the ongoing rotation from investment to consumption which put downward pressure on demand for CapEx commodities used in infrastructure and manufacturing, such as steel, relative to OpEx commodities exposed to consumer spending, such as oil.

Medium term, we believe that the decline in drilling activity around the world is still setting the stage for an eventual recovery in prices. For now, our 2017 outlook remains unchanged, with demand and supply projected to remain in balance and WTI oil prices to average $53/bbl, with a 1H 2017 expected trading range of $45-$50/bbl. The risks around this forecast remain high, however, with our forecasts conservative on both further low cost production growth and further disruption reversals, which combined represent today 1.6% of global supply, the equivalent of the average global oil surplus observed during 1Q 2015 – 1Q 2016.

Assuming, for example, that global supply exceeds our forecasts by 400 kb/d (0.4%), our models imply that oil prices would need to average $43/bbl on average next year. Such a scenario is not that unlikely as it could be reached either (1) with half of Libya’s and Nigeria’s current disruptions reversing, (2) 2017 non-OPEC new projects coming online in line with company guidance instead of our lower ‘risked’ forecasts, or finally (3) Iran and Iraq delivering on their advertised production growth instead of our more conservative expectations.

Given our outlook for a well supplied market and a crude curve in contango with limited spot upside, we continue to recommend being short the S&P GSCI Crude Oil index, especially paired with positive yielding oil-exposed assets such as HY E&P credit, which is our recommended Top Trade #8.

 

 

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