OVERVIEW: CONCERN OVER RECORD HIGH CRUDE OIL PRICES
By Dave Shellock
Financial Times (London)
May 23, 2008
A dramatic surge in oil prices provided the main focus for financial markets this week as inflation and growth fears remained at the forefront of investors’ minds.
West Texas Intermediate, the benchmark U.S. oil price, continued its meteoric rise, peaking at $135.09 a barrel amid continued worries that demand would outstrip supply within the next few years. Long-term prices rose even more sharply, fuelling fresh fears about global economic growth.
“It looks like the trade-off between stubborn inflation and inflation expectations versus monetary policy and growth is going to be the summer’s focus,” said Richard Reid, European market economist at Citigroup.
According to the global economics team at Merrill Lynch, the inflation shock has already happened.
“For the first time in our memory, inflation, not growth, is the primary macro driver at the global level,” they said. “What matters now is how persistent it is and how markets and policymakers react.”
The minutes of the Federal Reserve’s last policy meeting showed that that the U.S. central bank had slashed its growth expectations and raised its inflation forecasts for this year. The latter, along with its characterization of April’s decision to cut interest rates as a “close call,” led many in the markets to speculate that the Fed’s easing cycle had come to an end.
“The clear conclusion from all of this is that the Fed is extremely unlikely to ease again, unless the situation in the financial markets begins to worsen dramatically again,” said Michelle Girard, Strategist at RBS Greenwich Capital.
Comments from Fed vice-chairman Donald Kohn, and robust U.S. wholesale inflation data, appeared to back up that view.
Meanwhile, strong producer price figures and sentiment surveys in Germany prompted the markets to price in a rise in eurozone interest rates this year -- although this view was challenged on Friday by evidence of substantial weakness in the services sector.
Marco Valli, economist at UniCredit, said the data were consistent with the view that eurozone growth would stagnate in the second quarter.
“Given that headline inflation will remain above 3 per cent for several more months, it is plausible to assume that the ECB will see the ongoing GDP moderation as necessary to neutralize mid-term price risks, and therefore won’t be thinking about cutting rates soon,” he said.
“But our core view is that this is not a mid-cycle slowdown, as the ECB thinks, but rather the beginning of a genuine cyclical downturn.”
The heightened concerns about inflation left European government bonds sharply lower over the week, particularly at the short end of the curve. The two-year Schatz yield rose 22bp to 3.99 per cent, while the 10-year Bund yield gained 9bp to 4.27 per cent.
UK Gilts suffered similar losses, with the two-year yield climbing 19bp to 4.99 per cent -- after surging 46bp in the previous week.
The Confederation of British Industry’s latest industrial trends survey showed that U.K. manufacturers expected to raise prices at the highest rate for more than a decade.
The 10-year U.S. Treasury yield was up just 2bp at 2.47 per cent and the 10-year 1bp higher at 3.86 per cent -- although the muted moves over the week masked volatile daily swings.
Tim Bond, head of global asset allocation at Barclays Capital, said U.S. bond markets were a clear sell.
“The combination of easing credit market pressures, better U.S. growth, and soaring inflation is likely to cause carnage in the fixed income markets this summer,” he said.
“The sole rationale for owning bonds at current negative real yields is to hedge the risk of a recession. The odds in favor of such a risk materializing have fallen sharply over the past few weeks.”
On the currency markets, the Fed’s gloomy assessment of the U.S. economic outlook and the heightened expectations of higher eurozone interest rates helped drive the euro back above $1.58 to a four-week high.
Sterling, meanwhile, found support from fresh speculation that further U.K. interest rate cuts were off the cards after the CBI report and data showing a much-smaller-than forecast drop in retail sales last month.
Sentiment towards equity markets saw a dramatic turnround after the leading indices hit four-month highs on Monday.
By the close in New York on Friday, the S&P 500 was 3.5 per cent lower for the week, its biggest weekly loss since February.
The pan-European FTSE Eurofirst 300 index fell 3.1 per cent -- its worst showing since early March -- while in Tokyo, the Nikkei 225 Average shed 1.5 per cent.
There was also a big mood swing in the credit markets after the improvement of the previous week. The iTraxx Crossover index, a closely-watched barometer of broad credit quality, rose 48 basis points to 454bp.
The investment-grade CDX North America index shot back through the psychologically important 100bp mark.
TEETH GRITTED, DRIVERS ADJUST TO $4 GASOLINE
By Jad Mouawad and Mireya Navarro
New York Times
May 24, 2008
Hating every minute of it, Americans are slowly learning to live with high gasoline prices. For a nation accustomed to cheap fuel, big vehicles, and sprawling suburbs, the adjustments are wrenching.
Cory Asmus of Temecula, Calif., just bought a $4,800 motorcycle for his 20-mile drive to work so he could cut his gas bill to $8 a week, from $110.
Florian Bialas, a retiree who lives near Chicago, sold his Pontiac Sunfire for $3,000 and plans to give up his license when it expires in September. “I can walk to most places where I need to go,” he said.
And Debbie Gloyd of Cleveland has parked her Chrysler Concorde and started taking the bus to work. “I can’t afford these gas prices,” she said. “They’re insane.”
With the nationwide average price for regular gasoline closing rapidly on $4 a gallon, people are bracing for a summer of expensive driving.
As the Memorial Day holiday starts the summer driving season, record prices are provoking dread and upsetting vacation plans. A recent survey by AAA, the automobile club, found a rare year-on-year decline, of 1 percent, in the number of people planning to travel this summer.
Interviews with more than 70 people across the country suggested that the adjustments they were making, mental and otherwise, would last well beyond the summer. Americans have started trading their gas guzzlers for smaller cars, making fewer trips to the mall and, wherever possible, riding public transportation to work.
For years, it was not clear whether rising prices would ever cause Americans to use less gas. But a combination of record prices, the slowing economy, and a tight credit market has beaten consumers down.
Gasoline demand has fallen sharply since the beginning of the year and is headed for the first annual drop in 17 years, according to government estimates.
The Transportation Department reported Friday that in March, Americans drove 11 billion fewer miles than in March 2007, a decline of 4.3 percent. It is the first time since 1979 that traffic has dropped from one March to the next, and the month-on-month percentage decline is the largest since record keeping began in 1942.
High gasoline prices, plastered on 20-foot signs from coast to coast, are turning into a barometer of the country’s mood.
“The psychology has changed,” said Sara Johnson, an economist at Global Insight. “People have recognized that prices are not going down and are adapting to higher energy costs. It’s a capitulation.”
Typically, gasoline sales rise before Memorial Day weekend. But gasoline sales dropped nearly 7 percent last week compared with the same week in 2007, according to an estimate by MasterCard.
Gasoline prices almost always rise in the summer, as demand increases. On Friday, gasoline prices reached yet another record, a nationwide average of nearly $3.88 a gallon. That figure was up 4 cents in one day and is 65 cents higher than this time last year, according to AAA. Diesel hit $4.65 a gallon on Friday, up $1.73 a gallon in a year.
The force behind high gasoline prices is the high price of oil, which is being driven up by soaring worldwide demand. Oil reached a record above $133 a barrel this week, nearly five times as expensive as it was five years ago.
All this has led to a vast transfer of wealth from American drivers to domestic and foreign oil producers. Every one-cent increase in gasoline prices means Americans pay $1.42 billion more a year for gas, according to Stephen P. Brown, an economist at the Federal Reserve Bank of Dallas. Nearly two-thirds of that goes to foreign producers.
In the first four months of the year, Americans spent $158 billion on gasoline. In 2003, just as oil prices started to take off, they spent $88 billion over the same four-month period, according to Michael McNamara, vice president for MasterCard’s Spending Pulse, an indicator of weekly gasoline sales.
Whether today’s high costs will translate into a permanent change in behavior remains to be seen, of course. The Energy Department expects gasoline sales to fall by 0.6 percent this year, the first drop since 1991, but it expects consumption to rebound in 2009 as the economy strengthens.
Still, analysts said that the hardship induced by today’s prices is getting close to the level reached during the oil shock of the early 1980s.
Americans spend 3.7 percent of their disposable income on transportation fuels. At its lowest point, that share was 1.9 percent in 1998, and at its highest, it reached 4.5 percent in 1981, said Ms. Johnson of Global Insight.
Still, despite the rise in energy prices, gasoline remains cheaper in the United States than in most industrialized countries. In France, for example, a gallon of gasoline costs about $7.70 at today’s exchange rates. Also, Americans pay less to drive a mile today than they did in 1980, once the impact of inflation and gains in fuel efficiency are taken into account, said Lee Schipper, a visiting scholar at the transportation center of the University of California, Berkeley.
Mr. Schipper estimates that the cost of gasoline for each mile traveled will be about 15 cents this year. That is nearly three times the low of 5.6 cents a mile reached in 1998, when fuel efficiency peaked and prices were at their lowest. But it is still cheaper than the record paid in 1980 of 17.1 cents a mile, adjusted for inflation.
The oil shocks of the 1970s and 1980s introduced the nation’s first efforts to curb consumption, including the first fuel efficiency standards and scaled-back speed limits. These had an impact on gasoline demand, which fell each year from 1979 to 1985. But then oil prices collapsed, political pressure evaporated, and many consumers lost interest in small cars.
“This is the wake-up call,” Mr. Schipper said. “We actually have a lot of choices, based on what car we drive, where we live, how much time we choose to drive, and where we choose to go. But you have built in a very strong car dependency. And when the price hits the fan, people have a hard time coping.”