Quarter 3 Statements

OIL

Oil prices have been extremely volatile this year with many economic and political factors keeping prices elevated and at the same time capped. The war in the Ukraine was a major catalyst that resulted in oil prices skyrocketing on account of supply disruptions as well as collective agreements between some nations to not purchase oil from Russia in a desperate attempt to decrease their funding for the war. Additionally, China has still been battling with Covid in certain regions resulting in their implementation of further lockdowns to stop the spread of the virus. This Zero-Covid policy continues to affect their economy causing an unprecedented slowdown in growth. As a result, their oil imports have dropped and with China being the world’s biggest importer of oil, this has caused a great deal of downward pressure on prices.  Concurrently, the rest of the world is also battling with the risk of a recession, which appears to be increasing as nations continue to increase interest rates as a means of taming inflation. With the outlook for a global slowdown in growth appearing more, probable prices have reacted by staying below the $100 mark for brent crude.

An ongoing trend in the oil industry, is that when prices come down, OPEC+ retaliates by cutting oil supply in an attempt to keep prices elevated and their profit margins large. Most recently they decided on a 2 million barrel cut in daily supply which caused a large uptick in prices. Contrarily, the Biden administration has announced an increase in withdrawals from the Strategic Petroleum Reserve (SPR). This is the world’s largest supply of emergency crude oil which was established primarily to reduce the impact of disruptions in oil supply and to keep oil prices low for the American people. Since the beginning of the year The Biden Administration has been depleting the SPR at an alarming rate to get oil prices low in time for the midterm election in November. With this recent increase, the entire reserve is expected to halve this month and hit a 40 year low in November. In addition to this, the rest of the world have also been selling their reserves , producing the largest coordinated oil reserve release in history.  When these reserves are replenished in the coming years oil prices can be expected to surge higher again and intern inflation will remain at elevated levels for longer.

Additionally, the US has ramped up production of oil to further bring down prices domestically and abroad. Currently, the US is a net exporter of oil and it is likely that this will be the case for the foreseeable future. Decreasing any of its oil exports would risk angering countries that depend on US supplies. Recently, US oil companies have issued statements that any bans on oil production would increase domestic fuel prices and potentially alienate US allies during a time of war.

UK Economic Situation:

In the last weeks and months, the markets have felt like a category 5 storm. Britain is in a self-inflicted financial crisis that threatens to accelerate the economy’s dive into a recession. While the Bank of England raised rates to curb inflation, the government unveiled the biggest tax cuts since 1972 with little detail of how they will be financed. However, this decision has since been changed and the Bank of England has been forced to intervene amid concerns about the nation’s pension funds. During this time the pound has crashed to its lowest level against the dollar

British house prices fell for the second time in three months in September and rising borrowing costs are likely to exert “more significant downward pressure”. UK businesses expect to raise their prices at the fastest pace since records began to offset higher wage costs driven by a tight labour market in October. UK households are urged to reduce energy use to avoid winter power cuts – National Grid warns of three-hour blackouts in ‘extreme’ gas and electricity supply shortages.

The outlook for European gas markets remains one of the most important drivers of European inflation and economic expectations. The sharp increases in gas and electricity prices in Europe means that households will see a steep rise in the cost of their energy consumption. Accordingly, some governments have announced emergency support packages with a value of 1.5% to 7% of GDP. Emergency measures include a cut to electricity demand (10% overall voluntary cut and 5% peak demand mandatory cut), a cap on revenues for non-gas power generators, a “consolation contribution” from fossil fuel companies, and measures to support small enterprises. As is the case with oil, markets remain tight with little new gas supply expected to come onstream before the end of 2025, which skews price risk to the upside and could lead to further downgrades to European GDP growth forecasts in 2023/2024.

Prime Minister Liz Truss had made some major moves in her short time as prime minister. She had set a path where monetary and fiscal policy work against each other. Her last rash decision was to fire the Finance Minister Kwasi Kwarteng, less than six weeks on the job, amid mounting political pressure and market chaos. She has since resigned as Prime Minister of the UK. New Prime Minister Rishi Sunak, went to the boarding school Winchester College, then studied Philosophy, Politics and Economics at Oxford, and business at Stanford in America. He is now the first British Asian prime minister. He has only been an MP for seven years and was previously Finance Minister since 2020.

The “mini-budget” heightened concerns about inflation, already near a 40-year high, and a spiralling government debt burden, which triggered a market sell-off of the pound and bonds. This new fiscal support implies that the BoE will now need to tighten policy more aggressively than it otherwise would have to counteract the additional price pressures stemming from the fiscal stimulus. This backdrop of stimulative fiscal policy resulting in growing budget deficits combined with tight monetary policy is an adverse mix for financial markets.

Unfortunately, greater fiscal support and stimulus means that monetary policy will be tightened more aggressively, as painfully illustrated recently in the UK. With high interest rates, high inflation, increased volatility, and political uncertainty, it appears that there are some difficult times ahead for the UK.

Federal Reserve – Rate Hikes

Global markets took another knock over the quarter, with equities and bonds finishing the quarter down 6% and 7% respectively. The S&P500 has declined by 28% year to date which officially signaled that we are in a bear market. This is primarily due to a 3% increase in the US Fed Funds rate over the last 7 months. Economic forecasts are being revised downwards, with the US expected to enter a mild recession by 2023.

The 3% increase is comprised of a 0.25% hike in March, followed by a 0.5% hike in May. These slight rate hikes were considered to be sufficient at the time, as the Fed expressed a view that inflation was transitory. This has since been proven otherwise as inflation has spiraled out of control. This resulted in the Fed making three consecutive 0.75% rate hikes. However, it is noteworthy that the Fed is yet to enter restrictive monetary policy. These aggressive rate hikes have resulted in increased volatility in the market. This shows that the Feds’ ideology is not to be the same as the Fed of the 1970’s. For some context, the Fed of the 1970’s let off the brakes too soon by completely halting the increasing of interest rates before it has moved above inflation, this caused inflation to further spiral out of control to reach a peak of 14.2% and resulted in the Fed having to raise the Fed Funds Rate to 20.0% which caused a deep recession in the US.

In July, the market started to focus on the possibility of interest rate cuts from the US Federal Reserve in 2023, given concerns about slowing growth. However, such hopes were dashed at August’s Jackson Hole summit, where the Fed reaffirmed its commitment to fighting inflation, while disregarding growth. US core inflation which comprises of goods and services has been increasing while other factors such as energy and food-based inflation has started to decline. This is the reason for headline inflation not decreasing by a meaningful percentage.

A rising rate cycle driven by what is likely sticky inflation factors combined with a slowdown in growth hardly feels like an attractive investment environment. The counter argument is that markets are forward looking mechanisms. Inflation and interest rates will reach their peak and decline to acceptable levels.