Streak over for AC/DC?

AC/DC is back and we’re thrilled!  

 

Using AC/DC as a leading indicator, we could see big trouble ahead for the global economy - or maybe not.

1973: AC/DC form in Sydney, Australia - Economy: Start of the oil crisis, which saw the price quadruple

1980: AC/DC release breakthrough album Back In Black - Economy: Inflation in UK reaches 20% and unemployment nears 2 million

1990: AC/DC score comeback with The Razor's Edge - Economy: Recession in UK imminent

2008: AC/DC top UK album charts - Economy: Biggest world recession in decades looms

December 2014: AC/DC release their new album, Rock of Bust - Economy: ???

Shifting Expectations

The dominate themes in last week’s trading were the continued drop in the price of crude oil, the angst in the U.S. equity markets ahead of Q4 earnings season, and the disappointing U.S. December jobs report. This caused investors looking for yield to move from the negative and low yielding currencies to the high yielders of the NZD and AUD. The yen moved higher as the carry trade unwound due as nervous equity traders looked to peel back from equity positions. Meanwhile the USD benefited from the weakness in CAD due to lower crude prices; GBP due to evidence of slower growth; CHF due to efforts by the Swiss central bank to maintain the EUR/CHF 1.20 peg; and euro due to more signals that the ECB’s balance sheet will return to 2012 levels.

In last week’s ‘Weekly FX Update’ we stated the following: the dominant support behind the rise in the USD continues to be the “divergence theme” – a U.S. economy growing at a 4% clip and a central bank ready to deliver an interest rate hike by mid-year, while additional stimulus is required in the rest of the world. The USD turned in a mixed performance last week because the market’s collective expectation on the timing of the Fed’s first interest rate hike near mid-year has been put into question. The CME Group FedWatch tool shows a 52% chance of a September rate hike which is down from the 57% chance it showed on Thursday, the day before the jobs report was released.
http://video.cnbc.com/gallery/?video=3000344746

On the surface, the headline jobs number looked good as over 252K jobs were created in the month of December, more than the market’s 240K forecast. In addition, the previous two months were also revised up by 50K. The unemployment rate fell from 5.8% to 5.6%, the lowest level since June 2008. Unfortunately, the 252K jobs was the weakest monthly jobs growth since August and more importantly the data on wages was a major disappointment. Average hourly earnings dropped 0.2%, which was not only the first decline in more than 2 years but also the largest drop ever. The year-over-year rate slumped to 1.7% and if this continues it will become a major obstacle for the Fed.

One report does not make a trend so we will have to wait and see how this plays out. The jobs report was enough to trigger profit taking on long USD positions. The news flow in the week ahead will probably reinforce the rethink about the king dollar thesis and spur a consolidative move in the USD. U.S. consumer inflation, producer prices, retail sales, and the Beige Book report are on the docket this week. With deflation being a dominate theme worldwide we suspect that the U.S. economy is not immune to it so we do expect consumer and producer prices reports to reflect weaker prices in the December reports. Also worth considering are four speeches to be given by Fed speakers this week. Lockhart and Kocherlakota are noted doves, Bullard is a centrist, and Plosser is a hawk.

Historical Effects of Falling Oil Prices

On a year-over-year basis, the price of oil has dropped over 35% a total of 7 times in the past 30 years. Out of those 7 times, a recession followed the steep decline in prices a total of 3 times. However, each time there was a recession following a dramatic drop in oil prices (September 1991, October 2001 and October 2008) the U.S. economy was already in a recession or it was imminent.

The impact of oil prices on the U.S. energy sector is obvious and the market has already marked the sector down by 25% by the end of Q4 2014. The manufacturing sector, however, should accelerate heading into 2015 as output should intensify resulting from cheaper manufacturing costs. With the energy sector factored in, overall capital spending should also increase. The major risk to the U.S. economy and growth is inflation. The Fed is obviously watching signs of inflation to determine when to raise interest rates. Once the price of oil stabilizes and consumers realize savings on heating and transportation, the result should demonstrate an increase in spending and, therefore, rising demand. The fall in oil prices should add approximately $75 billion a year to spend on other goods for American consumers, which is about 0.7% of total U.S. consumption.

How far do you think oil will drop?

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