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Making Sense of Falling Oil Prices and ECB QE

falling oil prices
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bondsquadwebbannerThe market is waiting with great anticipation for the ECB to launch full-blown QE. It is believed (hoped) that full-blown QE will reinvigorate the EMU economy. What pundits and investors apparently do not realize (or understand) is the QE has already effectively taken place. What is the goal of QE? It is to lower borrowing costs across an economy. The bond market has already accomplished this. During the past year, the yield of the 10-year German Bund has fallen to 0.50% from 1.907%, this time last year. Italy’s 10-year sovereign debt yield has plunged to 1.80% from 3.94%, this time last year. In Europe, five-year interest rates are the most popular lending benchmarks. The story is similar. German five-year sovereign debt yields are in the neighborhood of -0.004% at the present time. This is down from 0.923% in January 2014. Italian five-year sovereign debt yields 0.85% this morning, down from 2.52% this time last year.

To see a list of high yielding CDs go here.

If the goal of QE is to lower interest rates/borrowing costs to stimulate the economy, Bond Squad believes we can safely say that ECB QE should be largely ineffective. After all, EMU sovereign debt yields (interest rates) have already plunged and the Eurozone economy continues to slow. However, ECB QE might be necessary to keep EMU sovereign rates low. All this will probably do is maintain the current status quo in Europe. Structural economic changes (or the ability for the most troubled economies to devalue currencies) are necessary to boost the EMU economy. Until then, the EMU will resemble a slow-motion train wreck. The currency markets are pricing this in with the euro trading around $1.19 this morning. 

The Kasbah Gets Rocked

Falling oil prices have generated much discussion in the capital markets. One “conundrum” is why financial markets have not responded more positively to what appears as an obvious positive for the U.S. economy. Bond Squad believes two realities are being ignored:

  1. Although falling oil prices can act as a tax cut for consumers, the result may not be as positive as a true tax cut. If the government cut taxes by $1,200 per household, the results would be nearly 100% positive as few (if any) jobs would be lost as result. In fact, jobs would probably be created. However, a $1,200 per year benefit via lower fuel prices could result in job or wage cuts in areas of the Country which experienced an energy boom. Maybe the fall in oil prices is 75% positive.
  2. Asset price performance has benefitted significantly from the energy boom and very aggressive consumption vs. supply estimates. Increased production and consumption which is running significantly below estimates has driven oil prices and oil revenues lower. This is a negative for the high yield bond market, which has been fueled (so to speak) by the energy boom. Some of these energy debt speculations might not pan-out for some investors. Equity valuations had priced in a global economy which could outpace the U.S. economy. The reverse appears to be true.

We do not believe the correction in high-risk fixed income assets is over. Bond Squad believes that crude oil prices could fall well into the $40 area, if not lower (at least in the near term). Economies which are almost totally reliant on oil production have little choice but to keep pumping to generate whatever revenue they can. This could result in downward wage pressure around the world as workers become ever more competitive for employment. Look for credit spreads to continuing widening in 2015. Corporate defaults and debt restructurings could increase this year, as well. Bond Squad views lower oil prices as a plus for Main Street, but not as beneficial for Wall Street, particularly aggressive investments, such as junk and EM debt.

By Thomas Byrne – Director of Fixed Income – Investment Consultantbondsquadwebbanner

Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.

Employment

  • November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
  • December 2011 – November 2012 – Bond Squad, Kunkletown, PA
  • April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
  • June 1986 – March 1988 – E.F. Hutton, New York, NY

Thomas Byrne
Director of Fixed Income
Wealth Strategies & Management LLC
570-424-1555 Office
570-234-6350 Cell

Twitter: @Bond_Squad

 

 

All trading carries risk. Views expressed are those of the writers only. Past performance is no guarantee of future results. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.
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Thomas Byrne

Thomas Byrne serves ad the Director of Fixed Income for Wealth Strategies Management LLC. Thomas brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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